Private equity entered 2025 with a familiar set of expectations: meaningful rate relief, a broad rebound in deal activity, a friendlier regulatory environment, and a more dependable exit market. None of those things materialized in the way the consensus imagined. Rate cuts were limited. Debt stayed expensive. Exits remained constrained, and an M&A boom under a pro-growth administration never materialized. We now see a new operating baseline – one that calls for different assumptions than most firms carried into last year.

Where the 2025 Outlook Went Wrong

The Recovery Was Real, but Concentrated at the Top

Deal activity recovered, but it was uneven. Large-cap transactions captured a disproportionate share of total value while overall deal count stayed well below prior peaks. For many mid-market firms, 2025 felt less like a recovery and more like a continuation of the caution that defined 2023 and 2024.

The same dynamic showed up in exits. Strategic acquirers were active, but selective, focused on high-quality, established assets where financing was available and competitive tension could be created. IPO windows opened briefly but never widened into a reliable channel. Sponsor-to-sponsor transactions stayed constrained by the same valuation gaps that slowed primary dealmaking.

A Pro-Growth Administration Didn’t Open the Floodgates

The incoming Trump administration was widely expected to catalyze an M&A surge, and on paper, the regulatory shift was real. The FTC under new leadership adopted a more pragmatic posture – granting early terminations, accepting divestitures over litigation, and signaling it would get out of the way for deals without competitive concerns. The hostility toward private equity as an acquirer class faded.

But the expected M&A wave never arrived at scale, particularly in the mid-market. The bigger constraints on dealmaking in 2025 were economic, not regulatory. Financing costs remained elevated. Valuation gaps persisted. Macro uncertainty around tariffs and inflation made it

harder to underwrite forward earnings with confidence. A more permissive FTC made deals easier to close, but it didn’t make them easier to price or finance.

Rate Cuts Didn’t Reset the Economics

Heading into 2025, the consensus expected a faster glide path to lower rates. That didn’t materialize. Cuts were limited, and the policy environment ended the year structurally higher than the easy-money conditions of the prior cycle.

More importantly, the downstream effects never reset. The cost and availability of leverage stayed tight. Underwriting remained conservative, spreads stayed wide, and many capital structures reflected uncertainty rather than renewed risk appetite. Firms that were waiting for cheaper debt to unlock pipelines spent another year doing exactly that.

The Macro Picture Got Harder, Not Easier

Macro complexity didn’t simplify in 2025 — it compounded on multiple fronts. Tariff expansion across multiple sectors introduced direct cost pressures into portfolio company operating models. Companies with exposed supply chains faced real input volatility, and even those without direct exposure felt second order effects through customers, vendors, and competitive pricing. Inflation proved stickier than expected. Labor markets softened in ways that affected demand visibility and workforce planning.

The combined effect was an environment where operating plans became less durable. Forecasts needed resets, not because business underperformed, but because the assumptions underneath them had shifted.

These pressures are not receding. Tariff policy remains expansionary, with additional actions expected across consumer goods and industrial inputs in 2026. Inflation continues to reflect cost pass through from earlier rounds, and labor markets show no signs of tightening in ways that would restore demand confidence. For PE-backed companies, this means the macro environment is not a headwind to wait out. It is an operating condition to build around.

AI Moved from Differentiator to Baseline Faster Than Expected

In early 2025, many PE firms still framed AI adoption as a differentiator. By year end, it was increasingly treated as a baseline expectation. What the consensus missed was how quickly the question shifted from “are you using AI?” to “what measurable impact has it had?”

Three Predictions for 2026

1. Operational Improvement and Execution Capability Differentiates Returns

Margin expansion, procurement savings, and productivity initiatives are no longer post-close upside. In an environment defined by elevated financing costs, compressed exit multiples, and persistent macro volatility, the ability to drive real operational improvement is a primary determinant of deal outcome. Firms that cannot reliably execute operational programs — not

just model them — will find that neither market conditions nor financing structures leave room for shortfalls.

What makes 2026 different is the depth of operational capability required to compete. The firms that win — in auction processes, in lender conversations, and ultimately in portfolio performance — are those that can specify which suppliers, which contracts, what timeline, what systems investment, what business transformation is required, and who on the management team owns execution. Operational capability also means building resilience into portfolio companies. The best performing firms will stress-test margin structures against defined scenarios, treat bench strength and succession as execution prerequisites, and score supply chain flexibility as a quantified risk metric. Executing frameworks while absorbing inevitable disruptions — a tariff escalation, a key departure, a demand shortfall — without the deal thesis breaking is a cost of entry.

The ability to identify a good business at a fair price is necessary but not sufficient. The ability to make that business measurably better — on schedule, with real teams, against real plans — is what separates the firms that will generate returns from those that will not.

2. AI Delivers Provable ROI, but Only for a Handful of Firms

We expect a small minority of major buyout platforms to demonstrate measurable, attributable AI-driven performance improvements across multiple portfolio companies in 2026. The evidence will be in auditable financials, not slide decks. Successful firms will be those who invested in standardized data infrastructure, transformed operating models, and deployed repeatable playbooks, not one-off implementations.

The gap matters because AI capabilities compound. Unlike deal specific procurement savings, a working deployment model lowers execution risk on every subsequent investment. Firms still piloting AI fall further behind with each vintage. Commoditized applications get competed away as industries adopt the same tools. Proprietary implementations embedded in core operations offer more sustainable advantage.

3. Pressure from Aging Dry Powder Accelerates Deal Pacing, and Discipline Gets Tested

Despite record levels of dry powder, most firms maintained valuation discipline through 2025. They accepted slower pacing, tolerated longer holds, and resisted engaging in overheated processes simply to demonstrate activity. In 2026, we expect that restraint begins to erode at the margin. Funds raised between 2020 and 2022 are entering a phase where deployment pressure becomes structurally harder to defer, and the economics of management fees relative to invested capital will become more visible as capital remains uncalled. We expect overall deal pacing to increase, not because asset quality has improved materially, but because the opportunity cost of waiting rises.

The firms that maintain underwriting discipline while deploying under pressure will separate themselves. Those that accelerate simply to reduce optics around idle capital will compress returns and regret it in later vintages.

What 2026 Demands: The Execution Bar Has Permanently Risen

Measurement Replaces Narrative

The LP / GP relationship continues to shift from storytelling to evidence. Claiming operational value creation without attribution is insufficient. LPs want to understand what drove results, how sustainable those drivers are, and whether the approach is repeatable across investments.

That means initiative level tracking of margin improvements, transparency on organic versus inorganic growth, and defensible linkage between actions and outcomes. Firms that treat data infrastructure and KPI governance as core operating systems, rather than reporting afterthoughts, will find it materially easier to raise their next fund.

Management Strain Is a Real and Growing Risk

Running a PE-backed business in this environment requires sustained intensity over longer hold periods, tighter covenant structures, and faster delivery of improvements with less tolerance for setbacks.

Organizational durability, including realistic capacity assessments, is moving from a nice to have to a risk mitigant that directly affects financing confidence and exit outcomes. Firms that ignore management strain will see it show up in missed targets and blown timelines.

Final Thought

The firms most likely to outperform are those that have embraced this new baseline. They underwrite with real downside discipline. They deploy operating resources early, measure impact rigorously, and treat resilience as a quantified investment criterion. And they recognize the only sustainable edge is delivering those improvements reliably, even when conditions do not cooperate.

2026 will not be defined by a single catalyst. It will be defined by who can execute under compounding uncertainty, and who cannot.