Private Equity’s Guide to a Sustained Long-Term High-Rate Environment

In a landscape defined by sustained elevated interest rates, private equity (PE) firms must adjust their growth strategies. While the near-term rate path is expected to trend downward, rates are still high in context of recent history.

From economic realities and valuation dynamics to meticulous pre-investment analysis and planning for growth, read on to learn more about PE’s key areas of focus.

The Economics Around Higher Long-Term Rates

Long-term risk-free rates have been elevated for several years and are likely to remain above the lows of the early 2020s — signifying a "higher for longer" environment, even if those rates ease gradually over time. 

Reduced foreign demand for U.S. treasuries, structurally high fiscal deficits, and ongoing uncertainty surrounding the Trump administration's potential leadership decisions for the Federal Reserve contribute to this elevated-rate environment.

These forces have significantly impacted numerous facets of PE operations:

• Capital Structure Adjustments: When interest rates were near zero, some investment firms positioned themselves as an alternative to PE because they couldn't compete with direct lending funds or banks. In a high-rate environment, more opportunities have emerged for less cash-absorbing instruments. Nearly one-third (30%) of PE fund managers and operating partners report equity as their preferred financing source for acquisitions, according to BDO’s 2025 PE Survey. Equity or subordinated debt allows companies to invest while managing interest costs. There's also a recognized difference in pricing across markets, with Euribor materially lower than Secured Overnight Financing Rate (SOFR), requiring a cognizant approach to pricing.
• Cost of Capital and Exit Multiples: Higher rates directly translate to a higher cost of capital, which in turn changes the multiples that businesses can command upon exit. This dynamic leads firms to rethink their capital structures, often opting for more conservative debt levels due to the cash consumed by higher interest payments. Even if policy rates begin to decline, the cost of capital may remain higher than in the prior decade. 
• Challenges in Exits: PE firms have experienced a long time period of cheap debt which helped support higher multiples through supportive financing. Now, there is a significant delay in merger and acquisition (M&A) exits due to a mismatch between purchase and achievable sale prices. BDO’s 2025 PE Survey found that 63% of fund managers report that their fund’s average holding period is 5 years or more, and 84% of fund managers and their operating partners report that their average holding period increased over the last year. While IPO activity somewhat improved from 2024 into the first half of 2025, the market remains sluggish, particularly for smaller or less profitable companies, amid ongoing uncertainty.
• Discount Rates and Valuation: While firms don't necessarily change their overall targeted returns, they are adjusting the composition of their returns in response to market factors. Firms are also taking a more conservative approach with realistic exit prices, increasingly viewing historical transaction comparables from 2020-2022 as less indicative of future expectations. Underwriting models are based on actual interest rates obtained from lenders, with risk premiums varying by industry and business, rather than a single standard discount rate or average cost of capital. One area where this is especially evident is the terminal value during valuation since a higher discount rate pushes down the present value, putting pressure on valuation.

Multiple Expansion Versus Growth

Decades ago, PE value creation often stemmed from leveraging and optimizing a portfolio company’s (portco’s) capital structure. Now, however, portcos must grow even faster to outpace their discount rate and maintain or exceed their initial multiple. This shift suggests that firms may focus more on revenue growth and margin expansion, with less uplift expected from multiple expansion over the next few years — even if rates ease from current levels.

PE firms must also contend with the "unbridgeable bid-ask" spread between sellers and buyers, which is contributing to reduced deal activity. Firms are reluctant to mark down their investments based on prevailing lower market multiples, preferring to make adjustments based on operational performance instead. This approach creates a situation where companies are performing well, but their perceived market values are significantly greater than what buyers are willing to pay. As a result, many firms hold onto assets for much longer than they had originally intended to avoid crystallizing losses.

Additionally, the current comparables for transactions are often inflated by selection bias, as only the highest quality, "cream of the crop" assets are trading while others are being held. This trend suggests anticipated multiple pressure over the next couple of years as more assets eventually come to market.

There is a strong correlation between higher revenue growth and higher earnings before interest, taxes, depreciation, and amortization (EBITDA) margins consistently yielding better multiples compared to lower-performing peers. Gross margin and cash flow are also crucial drivers of a portco's multiple. While investor sentiment and industry attractiveness can influence multiples independently, once an investment is made, improving operating margins and driving revenue growth are the best actions to enhance asset value.

The composition and quality of revenue are also critical value drivers, especially in traditional sectors like manufacturing or professional services. Underwriters should focus on opportunities to increase revenue recurrence, contractual nature, and diversification, addressing over-dependence on single geographies or customer concentrations to drive multiple expansion.

Pre-Investment Analysis and Planning for Growth

In the current elevated-rate environment, it is paramount to have conviction in the base levels of growth and profitability being underwritten for a business. Unlike in the past where multiple expansion might have compensated for not quite hitting numbers, firms now need to meet their targets.

Pre-investment analysis and planning for growth involve several critical components:

The Challenge of Improving Margins While Simultaneously Investing in Growth

The dual objective of growing a company and improving margins is an ideal deal theses and goal. However, without a strong strategic plan, extensive operational and commercial scenario planning, rolling up multiple companies to leverage scale, and/or implementing multiple value creation opportunities, growing while simultaneously cutting costs can be difficult to achieve.

A few factors contribute to this dynamic — for example, when entering a rapidly growing, new segment where customers are less price-sensitive and seeking a partner for guidance, though this ideal scenario is rarely permanent. 

Success also hinges on delivering something demonstrably better than competitors, whether in product, service, or go-to-market strategy. The ultimate determinant of value and margin is what customers are willing to pay for the offering, necessitating continuous differentiation and responsiveness to customer needs.

Additionally, many PE investments, particularly in founder-owned businesses, start with operational deficits. These deficits might include a lack of formal sales structures, human resources, or dedicated FP&A functions. Firms often need to invest in filling these gaps early on, effectively "digging their way out of a hole" from day one. At the same time, they must also balance these investments with scaling. Maintaining growth requires ongoing investment in new products, services, and market entry, which can counteract margin improvements. Consequently, any material uptick in margins is often viewed with high skepticism by investment committees. If companies prioritize protecting existing margins over investing in new, potentially disruptive, technologies or segments, they risk product obsolescence. The fear of "self-cannibalization" can lead businesses to stay in narrowing, slowing lanes, ultimately losing relevance. 

The era of relying heavily on leverage and automatic multiple expansion for value creation is largely over. Success in this elevated-rate environment demands a rigorous focus on organic revenue growth, operational efficiency, and a deep, continuous understanding of customer needs. Pre-investment analysis must be more thorough and skeptical, validating management plans against market realities and investing in critical enablers like strong management teams and robust technology infrastructure. 

Navigating this new PE environment is like rafting through increasingly turbulent waters. Firms can no longer rely on a straight line down the river as the fastest route through the rapids. Instead, they must meticulously make a plan, course-correct as conditions evolve, ensure their paddling colleagues are top-notch, optimize every part of the vessel, and constantly adapt to changing currents and emerging obstacles — or risk being left behind by more agile navigators.