Capital Markets Update – Q1 2025

Capstone Partners Q1 2025 Capital Markets Update

Wag the Dog

If you feel like the Opinion section of the newspaper reads more like a George Orwell novel these days, you’re not alone. Reporters have been breathlessly churning out headlines in the first half of 2025 as the markets have roiled. External shocks have included the announcement and subsequent rollbacks of various tariffs, cuts to federal agencies caught in the teeth of the Department of Government Efficiency (DOGE) chainsaw, and, of course, the rise of artificial intelligence (AI). So where do the markets stand amid the increased volatility?

The truth is that while disruptive in the short term, tariffs are unlikely to drive major changes in mergers and acquisitions (M&A) in the medium term in the U.S. for one simple reason: three quarters of our gross domestic product (GDP) is generated from services. The Trump Administration endeavors to use U.S. trade policy to reorder the world economy for goods. It is hard to assess tariffs on services and harder still to tariff an idea. So, investors focused on mercurial tariff policy and the machinations of DOGE are missing the plot. Policy battles playing out in Washington are merely the sideshow to the main event. When the dust settles from the trade war, the reordering of the knowledge economy at the hands of generative AI will come into clear view—that is the story to follow.

Microsoft (Nasdaq:MSFT), unquestionably one of the leading players in the AI revolution, quietly laid off 3% of its workforce, about 6,000 employees, in May. Employees of big technology firms see the writing on the wall and are buffing up their resumes. These firms simply don’t need as many developers now that they have equipped teams with powerful coding technology and other generative AI.

This is just the beginning of a new phase of creative destruction that will sweep across the biggest parts of our economy. Robert Smith, the savant software investor and billionaire founder of Vista Equity, took to the stage of the SuperReturn conference in Berlin and told the vast audience, “We think that next year, 40% of the people at this conference will have an AI agent and the remaining 60% will be looking for work.” His warning was stark: get on the train or get run over by it.

Investors focused on mercurial tariff policy and the machinations of DOGE are missing the plot. Policy battles playing out in Washington are merely the sideshow to the main event. When the dust settles from the trade war, the reordering of the knowledge economy at the hands of generative artificial intelligence will come into clear view.

Brendan BurkeHead of Sponsor Coverage, Capstone Partners

The deal volume of middle market M&A fell 2.6% in the first quarter of 2025 when compared to the prior quarter. When the books are closed on the second quarter, we expect similarly anemic activity levels as “Liberation Day” hijinks scuttled many deals scheduled to close over the following months. Naturally, companies with cross-border supply chains and contractors to the federal government are at the epicenter of the DOGE and tariff nuclear fallout. However, firms directly impacted by these policies make up a small percentage of our sell-side clients. Sponsors worry more about the secondary and tertiary effects of the tariffs and the cuts. In other words, sponsors are trying to time the market and avoid making major platform investments in case the skittish economy barrels into recession. Good luck with that.

As we put pen to paper in early June 2025, the private equity prairie dogs are starting to poke their heads out of their holes and recall that they are meant to deploy capital across all market conditions. Further, investors are coming to expect the unexpected from the Trump Administration. Investors simply need to underwrite to serial, fabricated “crises” as the normal state of affairs in Washington for the next three and a half years.

At Capstone we are behind our normal clip of sell-side dealmaking in the opening months of 2025, but remain cautiously optimistic for the second half of the year. With the imminent recession case seeming less likely by the day and the market still projecting three quarter-point reductions in 2025, we may witness a strong M&A market in the back half of the year. Private equity origination professionals have signaled improving deal flow the back half of the second quarter. Clearly, investment bankers are testing the market with new product to see if private equity demand is durable throughout this cycle.

Download our full Q1 2025 Capital Markets Update Report Publication:

Request instant access to the full Capital Markets Update for a deep dive into recent Middle Market activity and trends including:

• Key considerations for middle market business owners regarding dry powder levels, buyer appetite, lending conditions, and M&A pricing trends.
• An update on middle market valuations across 12 key sectors.
• An overview on Equity Capital market conditions, featuring Capstone’s Equity Capital Advisory
• A case study from Capstone’s Financial Advisory Services Group, detailing how data analytics and benchmarking support operational improvements and drive value creation.