Insights | Kapstone Equity Group

The Impact of Interest Rates on Private Equity Deals in 2025

Written by Ken Pomella | Jul 29, 2025 1:00:00 PM

Interest rates are a fundamental factor that influence investment decisions across all sectors, and private equity (PE) is no exception. In 2025, as the global economy continues to adapt to shifting market conditions, the cost of borrowing—dictated primarily by interest rates—will play a crucial role in shaping private equity deals.

In this blog, we’ll explore how interest rates affect private equity transactions, the challenges and opportunities they create, and how firms can navigate this environment to achieve favorable outcomes.

Why Interest Rates Matter in Private Equity

Interest rates are directly tied to the cost of debt, and because private equity transactions often involve leveraged buyouts (LBOs), the level of interest rates plays a crucial role in determining the structure of a deal. When interest rates rise, it becomes more expensive to borrow money, which can influence both the price of the acquisition and the amount of leverage used in the deal. Conversely, when interest rates are low, it’s easier to borrow at favorable terms, often leading to higher valuations and more aggressive deal structures.

At their core, interest rates impact private equity deals in the following ways:

  • Cost of Debt Financing: A higher interest rate means higher debt servicing costs, making leveraged buyouts more expensive.
  • Valuation Impact: The cost of debt directly impacts how much acquirers are willing to pay for a company. Higher borrowing costs can lower valuations.
  • Investment Strategy: Rising interest rates can push private equity firms to rethink their investment strategies, particularly regarding debt-heavy acquisitions.

Impact of Rising Interest Rates on Private Equity Deals

As of 2025, many economies around the world are dealing with inflationary pressures and shifting monetary policies, which could lead to higher interest rates. Here’s how rising rates are likely to influence private equity activity:

1. Higher Debt Servicing Costs

The most immediate impact of rising interest rates is the increased cost of borrowing. In private equity, many deals are financed through debt, and with higher interest rates, firms will face greater debt servicing costs. This means that for a given amount of debt, the business must generate more revenue to cover interest payments, potentially squeezing margins.

How it affects deals:

  • Lower returns on equity: As the cost of debt rises, the potential return on equity for the private equity firm diminishes. This can make some deals less attractive or force investors to reconsider their financial models.
  • Reduced leverage: With higher borrowing costs, private equity firms may look to reduce the amount of leverage used in deals. This could result in lower debt-to-equity ratios and potentially smaller deals.
  • Strain on cash flow: Companies already facing tight margins could find it more difficult to service their debt, especially in industries with slower growth or operational challenges.

2. Impact on Deal Valuations

Higher interest rates generally lead to lower valuations for businesses, especially for those where debt financing plays a significant role in the deal structure. Buyers are unlikely to pay a premium for a company if the costs of financing that purchase are higher, and this directly impacts the price a private equity firm is willing to offer.

How it affects deals:

  • Lower purchase prices: With the cost of capital rising, buyers may reduce their offers, leading to lower acquisition prices. This is especially true for businesses that rely heavily on debt financing to drive growth.
  • Pressure on multiples: Valuation multiples may come down as investors become more cautious about taking on risk. For instance, EBITDA multiples—common in private equity deals—may decrease as the costs of financing rise.
  • Selective deal-making: Firms may become more selective, focusing on businesses with strong cash flow generation or low capital needs, rather than highly leveraged companies with more risk.

3. Shifts in Investment Strategies

Rising interest rates will likely cause private equity firms to adjust their investment strategies to align with the new environment. High leverage may become less appealing, especially if debt servicing costs are high, leading to a shift toward more conservative financing structures.

How it affects deals:

  • Focus on lower-leverage deals: Private equity firms may shift toward lower-leverage buyouts or even equity-heavy deals, where the business is financed with less debt and more equity capital.
  • Greater focus on operational improvements: Firms may place more emphasis on improving the operational efficiency of portfolio companies to offset higher borrowing costs. This can involve enhancing profit margins, reducing costs, and focusing on organic growth rather than relying on financial engineering.
  • Acquiring businesses with strong cash flow: In a higher interest rate environment, businesses that generate consistent, stable cash flow will be more attractive because they are better equipped to handle debt obligations.

4. Exit Timing and Strategy

Higher interest rates can also affect the timing and structure of exits for private equity firms. When interest rates rise, the cost of debt financing for potential buyers increases, which can lower the demand for acquisitions or delay potential exits.

How it affects deals:

  • Slower exit timelines: Higher borrowing costs can lead to fewer buyers, especially for businesses reliant on debt for acquisitions. This may lead to longer holding periods for private equity firms as they wait for more favorable market conditions.
  • Exit via strategic buyers: Instead of focusing on financial buyers (such as other private equity firms), private equity firms may increasingly seek exits through strategic buyers who are looking for synergies rather than focusing purely on financial returns.
  • Consideration of alternative exits: In addition to traditional sales, private equity firms may explore other exit strategies, such as recapitalizations, where a firm raises capital through debt but retains ownership.

Opportunities in a High-Interest-Rate Environment

While rising interest rates bring challenges, they also present opportunities for private equity investors who are well-positioned:

1. Fewer Competitors in the Market

As borrowing costs rise, many competitors—especially those heavily reliant on debt—may step back from deal-making. This could reduce the number of active buyers in the market, giving those who remain a better chance of negotiating favorable deals.

What to do:
Private equity firms that are well-capitalized and can handle higher interest rates will be in a better position to secure attractive deals at lower valuations, as fewer buyers are competing for the same targets.

2. Acquiring Undervalued Assets

In a higher-interest-rate environment, companies with significant debt loads might struggle, creating opportunities for private equity firms to acquire undervalued assets. Distressed assets or companies facing debt-related challenges could be bought at lower prices, and private equity investors can unlock value through operational improvements and strategic changes.

What to do:
Look for opportunities in industries or companies that have strong fundamentals but are facing short-term financial challenges due to rising interest rates. Buying these companies at discounted prices can provide significant upside if you can manage the operational and financial restructuring effectively.

3. Focus on Non-Cyclical Industries

Certain industries are less sensitive to interest rate changes, such as healthcare, technology, or consumer staples. These sectors often maintain steady growth and profitability even during periods of higher interest rates. Targeting these sectors can offer more stability in a volatile market.

What to do:
Consider focusing on industries that have historically been less impacted by interest rate changes. These sectors may provide more attractive investment opportunities with lower risk.

Conclusion

Rising interest rates in 2025 will undoubtedly have a profound impact on private equity deals, influencing everything from valuations and deal structures to exit strategies. However, by understanding the implications of these changes and adjusting investment strategies accordingly, private equity firms can continue to find opportunities for value creation.

The key to navigating a high-interest-rate environment is adaptability. By focusing on lower-leverage deals, prioritizing operational improvements, and identifying undervalued assets, private equity investors can not only survive but thrive in a volatile market. With the right approach, private equity firms can continue to generate strong returns even as borrowing costs rise.