What’s Ahead for Private Equity: A More Selective Approach to Dealmaking
Key Takeaways
- Selectivity is defining private equity dealmaking. Higher financing costs and market uncertainty are raising the bar for attractive investments.
- Diligence is becoming more rigorous. Sponsors are placing greater emphasis on earnings quality, competitive positioning, and the durability of business models.
- Transaction structure matters. Earnouts, rollover equity, and purchase price adjustments may help bridge valuation gaps and allocate risk between buyers and sellers.
- Exit strategies require careful planning. Continuation funds can provide an alternative for sponsors seeking to retain attractive assets, but a clear investment rationale and transparent process remain important.
- Health care, software, and asset-heavy businesses are themes to watch in 2027. Investors are likely to continue prioritizing resilient fundamentals, defensible competitive positions, and long-term value creation.
Private equity firms still have substantial capital to deploy, but putting that capital to work has become more complicated. Morgan Stanley, citing PitchBook data, reports that more than $600 billion, or roughly 55% of U.S. private equity dry powder, now sits in funds more than two years old, a record high. Higher financing costs, persistent valuation gaps, and uncertainty surrounding AI and other market disruptions are raising the bar for attractive investments. Success increasingly depends not only on identifying promising businesses, but also on structuring transactions that account for risk and establishing a credible path to value creation.
That aging capital also creates pressure to deploy. McKinsey estimates that more than 40% of the dry powder available to general partners has been waiting for at least two years. KPMG has observed that, despite this wealth of capital, sponsors cannot easily deploy it without first demonstrating an ability to return capital to investors.
As a result, selectivity is becoming a defining characteristic of private equity dealmaking, influencing how sponsors evaluate opportunities, negotiate terms, and plan for exits.
The Cost of Capital is Changing the Investment Threshold
Private equity has always been a returns-driven business, but today’s rate environment has changed the threshold for what constitutes an attractive deal.
Higher borrowing costs leave sponsors with less room for error. Transactions that may have worked in a lower-cost environment, particularly those relying heavily on leverage to drive returns, now require closer scrutiny of growth assumptions, cash flow durability, and downside protection. Sponsors must be more disciplined about entry valuations and more confident in a business’s ability to generate returns under less favorable financing conditions.
This puts greater emphasis on operational improvement, defensible margins, and other tangible drivers of value creation. Buyers are increasingly focused on whether private capital can materially improve a company’s performance over the investment period, rather than relying primarily on financial engineering or favorable market conditions. The data supports this shift: Morgan Stanley reports that from 2022 to 2025, revenue and margin growth drove roughly 80% of exit MOIC, up from 55% in the 2015-2019 period.
Valuation Gaps Are Being Reinforced by Uncertainty
The gap between buyer and seller expectations is not new. But in the current market, that gap can be harder to bridge because uncertainty is coming from multiple directions at once.
Sellers may continue to look to historical pricing benchmarks established in a very different market. Buyers, meanwhile, are accounting for higher interest rates, more expensive debt, regulatory pressure, and sector-specific risks that may not have carried the same weight just a few years ago.
Software offers a useful example. Although it remains an important sector for private equity, AI-related disruption has introduced new diligence considerations. Bain & Company reports that uncertainty about what companies are worth caused technology deal value to drop 70% from the fourth quarter of 2025 to the first quarter of 2026, with fewer large software deals getting done, and Cherry Bekaert estimates that software deal value fell 65.7% year over year in the second quarter of 2026. Investors are increasingly evaluating the durability of a company’s product offerings, pricing model, competitive position, and customer relationships as AI reshapes the industry.
These uncertainties can also affect how transactions are negotiated and structured. Where buyers and sellers disagree on future performance or valuation, deal terms such as earnouts, rollover equity, and purchase price adjustments may help bridge expectations and allocate risk. Across sectors, sponsors are placing greater emphasis on earnings quality, competitive durability, and the assumptions underlying projected growth. These considerations are shaping both the diligence process and the negotiation of deal terms.
Larger Funds May Continue to Dominate Deal Value
One notable trend in the current environment is the concentration of capital in large and mega-cap transactions, which continue to represent an outsized share of overall deal value. Bain & Company reports that 2025 global buyout deal value rose 44% to $904 billion, even as the number of buyout deals fell 6%. The $56.6 billion take-private of Electronic Arts set a new all-time buyout record. That concentration has proven sensitive to financing conditions, however: EY reports that U.S. megadeal value fell 50% year over year in the third quarter of 2026 as borrowing costs weighed on the largest transactions.
Larger, more established funds often have greater access to capital, broader financing options, and more flexibility in determining when to deploy or exit investments. Fundraising reflects the same dynamic: With Intelligence reports that the 20 largest funds accounted for $171 billion of the $312 billion closed in the first half of 2026. These advantages can help them pursue larger transactions and compete for high-quality assets, even in a more uncertain market.
Middle-market sponsors face a different set of considerations. Valuations may vary significantly depending on a buyer’s assumptions about growth, leverage, and execution risk, creating opportunities for investors with sector expertise and a differentiated investment thesis. Some sponsors may also look beyond their traditional deal sizes to pursue smaller transactions with more attractive entry valuations or clearer opportunities for operational improvement.
Market data suggests the balance between large and mid-sized deals may be shifting. PwC reported that deals closing in the first half of 2026 skewed larger as capital concentrated in higher-conviction bets, but EY found that mid-market transactions supported U.S. deal activity in the third quarter of 2026 while megadeals lost momentum. PwC has also pointed to partnerships between private equity firms and AI companies as a potential new catalyst for transforming middle-market businesses.
Exit Strategies Are Becoming More Complex
Current market conditions are also affecting the exit phase of the investment cycle. Bain & Company has estimated that roughly 33,000 sponsor-backed companies remain unsold, and limited partners are increasingly focused on realized returns, with PwC describing distributions to paid-in capital (DPI) as the defining fundraising metric of 2026. The IPO market remains a key variable, particularly for larger assets. It showed renewed strength in 2026, highlighted by SpaceX’s record $75 billion IPO, but financing conditions and market volatility can complicate exit timing. When a traditional exit is not available on the preferred timeline, sponsors must consider alternatives more carefully.
Continuation funds remain an important option, particularly when a sponsor believes an asset has meaningful additional growth potential, but a traditional exit may not fully capture its value. GP-led secondary volume, the majority of which consists of continuation vehicles, reached a record $115 billion in 2025, up 53% year over year, and accounted for approximately 14% of all sponsor-backed exit volume, according to Jefferies. PitchBook also reports that the information technology sector’s share of GP-led secondary exit value has doubled since 2023. However, these transactions require a clear investment rationale and careful consideration of investor interests, valuation, and potential conflicts.
For sponsors considering a continuation vehicle, the challenge is to demonstrate why continued ownership offers a compelling opportunity for future value creation. A credible business plan, a well-supported valuation, and a transparent process can help establish the rationale for extending the investment horizon.
Investment Themes to Watch in 2027
Looking ahead to 2027, selectivity is likely to shape not only how sponsors evaluate opportunities, but also where they deploy capital. Health care may continue to attract investment given demand for essential services and opportunities for operational improvement, although reimbursement, regulatory, and other sector-specific risks will remain important considerations.
In software, investors will need to distinguish businesses with defensible products, durable customer relationships, and the ability to adapt to AI-driven change from those facing greater competitive or technological risk. Sponsors may also explore so-called “halo businesses” – asset-heavy companies with tangible assets, established operating histories, and potentially lower technological obsolescence risk. Energy offers one example: Cherry Bekaert reports that energy deal value rose 80.5% in the first half of 2026 compared with the first half of 2025, supported in part by the AI infrastructure build-out. Across these sectors, the common thread is a focus on businesses with resilient fundamentals and a credible path to long-term value creation.
At the same time, AI is not solely a source of risk. PwC notes that AI is simultaneously disrupting legacy software assets and unlocking new value creation levers across the portfolio, giving sponsors that integrate AI into their operating playbooks an additional path to improving performance.
Conclusion
Private equity capital remains available, but deploying it successfully requires a more deliberate approach to underwriting, deal structuring, and value creation. As financing conditions and competitive dynamics continue to evolve, sponsors will need to look beyond headline valuations and focus on the fundamentals that support long-term performance.
The firms best positioned for success will be those that combine disciplined investment decisions with rigorous diligence, thoughtful deal structuring, and a clear strategy for creating value throughout the investment lifecycle.
