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High rates and longer hold periods make earnings growth critical for PE returns
Private equity (PE) activity in the first half of 2025 remained muted, as the dual forces of sustained high interest rates and extended holding periods continue to reshape deal economics. Despite strong investor appetite and a desire to put capital to work, many sponsors are grappling with how to unlock value in a high cost of capital environment.
The challenge is clear: Increased holding periods and elevated interest rates have raised the required earnings growth needed to achieve target internal rates of return (IRR). For example, to achieve a 20% IRR with a 7% interest rate and a seven-year holding period, sponsors now need to deliver 4.2% annual earnings growth — more than double the 1.7% requirement with a 3% interest rate and seven-year holding period. As a result, achieving attractive outcomes now depends on delivering operational performance and strategic transformation. Thus, achieving the same IRR in today’s deal environment requires a fund to create two times the amount of enterprise value as they were previously.
This recalibration is evident in deal behavior. While deal volume has not materially rebounded, we are seeing concentrated activity in sectors that align with long-term growth trends or offer asset-light business models that generate resilient cash flows. Simultaneously, exits remain challenging with fewer realizations occurring, increasing pressure on sponsors to actively manage aging portfolios.
Themes to watch out for:
- Sponsors continue to focus on operational, commercial and strategic levers to drive returns.
- Topline growth increasingly driven by pricing, channel and product strategy.
- Embedding AI in portfolios to streamline operations, improve analytics and build competitive advantage.
- Longer hold periods prompting increased use of continuation funds, secondaries, restructuring strategies and retailization of funds.
- Carve-outs and complexity remain key avenues for value amid tight deal conditions.
We also noted that many private funds are renegotiating credit deals with lenders. These LMEs have roughly doubled in volume from prior-year levels, approaching highs not seen since the pandemic. This surge signals rising financial stress and a shift toward amend-and-extend strategies (keeping the same interest rate for a longer period rather than reducing lending costs) — underscoring the urgency for sponsors to create value and preserve optionality in a challenging exit environment.
Looking ahead
As we move into the second half of 2025, one development we’ll be watching closely is the increased reliance on liability management tools, particularly amendments and distressed exchanges. These moves reflect a growing urgency to buy time, manage maturities and avoid outright defaults while monitoring the portfolio companies’ liquidity and maintaining optionality to drive incremental value creation. By holding investments longer and avoiding costly refinancing or new equity infusions, investors are signaling a disciplined approach to downside risk — prioritizing capital preservation and operational resilience over aggressive recapitalization.
Meanwhile, exit options are tightening. The traditional IPO and strategic sale routes remain narrow, prompting many firms to explore continuation vehicles and secondaries as mechanisms to return capital. However, these paths bring new questions around pricing, governance and limited partner (LP) appetite — especially in a market where transparency and alignment are under greater scrutiny.
What will distinguish top performers in the months ahead is their ability to rethink portfolio strategy. Many firms are moving beyond first-wave cost takeouts and leaning into commercial reinvention — pricing optimization, sales effectiveness and AI-driven productivity are emerging as essential tools. Just as important is how and where capital is deployed. Dealmakers are favoring sectors that offer scalable growth with limited capital intensity, particularly in enterprise software, healthcare platforms and tech-enabled services.
“Sponsors are navigating fewer exits and constrained IRRs by leaning harder on execution: turning portfolio strategy into the primary engine of value.”
Kevin Desai,US Private Equity LeaderThe bottom line
Private equity must rely more heavily on value creation to drive returns in today’s environment of higher interest rates and longer holding periods. Operational excellence, commercial strategy and sector selectivity are critical in a market where exits remain challenging. In this environment, unlocking value through execution beyond capital deployment is essential to stay competitive and prepare portfolios for eventual exit opportunities.
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