We entered 2026 with a constructive outlook and many of the same optimistic signals we saw a year ago – momentum building out of the prior quarter, improving confidence, and the belief that deal and exit activity were poised to accelerate as market conditions improved.
One quarter in, the environment is starting to feel familiar – albeit for different reasons.
Geopolitical instability has reintroduced volatility into energy markets and inflation expectations, while growing scrutiny around AI disruption – particularly across software – is challenging broader assumptions around future growth and durability. Unlike this time last year, these factors have not stalled activity, but uncertainty has reemerged, resulting in more measured decision-making.
In Q4, we highlighted the middle market’s ability to adapt amid persistent macroeconomic and geopolitical uncertainty. That same adaptability remains critical in today’s environment.
This quarter, we explore how these dynamics are driving a widening valuation gap, reshaping how risk is underwritten, and increasingly flowing through to credit markets.
The Return of the Valuation Gap
Deal activity remains steady, but momentum is tempered – volatility and heightened buyer scrutiny, coupled with macro-driven uncertainty, have widened valuation expectations and raised the bar. Processes are still running, assets are being marketed, and capital remains available, yet fewer transactions are converting to close as buyers and sellers struggle to bridge the valuation gap.
Sellers, in many cases, remain anchored to valuations established in a fundamentally different environment and are not yet prepared to fully realize write-downs to meet current market levels. While improving sentiment and declining interest rates in 2025 helped narrow the gap, the underlying framework for assessing value has shifted. The past several years introduced meaningful distortions – driven by COVID disruption, inflation, and supply chain volatility – making historical performance a less reliable indicator of future results. Even when those factors are normalized, sellers are increasingly required to address forward-looking uncertainties, including the potential impact of sustained geopolitical cost pressures and the evolving influence of AI on business models.
This dynamic is most visible in the exit environment, where activity remains somewhat muted and outcomes are dictated by pricing alignment. Notably, this persists even as many middle market companies continue to report relatively strong underlying operating performance and internal confidence. The gap is not just a pricing issue, it reflects a broader recalibration in how buyers underwrite risk, durability, and future earnings potential.
Risk Repricing
Overlaying the valuation disconnect is a broader repricing of risk. Geopolitical instability driven by the prolonged conflict in the Middle East has elevated concerns around energy costs, brought inflation back into the narrative, and squashed the near-term potential for rate decreases. As a result, buyers and lenders are placing increased scrutiny on cost structures, margin durability, and overall earnings visibility.
At the same time, Q1 marked a shift in how AI-related disruption is being evaluated. The so-called “SaaS-pocalypse” highlighted a rapid increase in concern around the durability of traditional software models, with implications extending across industries as buyers and lenders reassess revenue quality, competitive positioning, and long-term growth assumptions.
Together, these forces are driving a more cautious approach to risk, narrowing the range of outcomes the market is willing to underwrite and setting the stage for tighter capital conditions.
Credit as a Forcing Function
The repricing of risk is now flowing through to the credit markets. Assets acquired at peak valuations in 2021, particularly across software, are now aging into a financing environment that is materially more selective. With spreads widening and lenders tightening around structure and leverage, the ability to refinance rather than exit is no longer assured.
Recent signals from the private credit market reinforce this shift. Investor redemption requests and increased scrutiny around credit quality suggest that what was once a highly accommodative source of capital is becoming more constrained. Lenders are responding with greater selectivity, tightening underwriting standards and placing increased focus on downside protection and asset durability.
At the same time, capital is beginning to reallocate toward areas with more predictable performance and lower exposure to disruption. The recent increase in investment in Heavy-Asset, Lower-Obsolescence (referred to as “HALO”) businesses is a clear example, as investors prioritize assets with tangible infrastructure, more stable cash flows, and limited downside exposure to AI-driven disruption. This shift reflects private equity’s ability to assess changing market conditions, adapt its focus, and continue deploying capital in areas where risk-adjusted opportunities remain compelling.
Taken together, these credit market dynamics could act as a forcing mechanism. For several years, sponsors have largely avoided realizing losses, supported by accommodative credit and continuation vehicles. As refinancing options narrow, GPs may be forced to confront the valuation gap that has constrained exit activity. While potentially painful in the near term, this may be the push needed to restore equilibrium across the private equity market.
Looking Ahead: Progress Requires Pressure
The current environment reflects a market in transition rather than contraction. While valuation gaps, tighter credit conditions, and elevated risk scrutiny continue to constrain near-term activity, these same pressures are beginning to reset expectations and reestablish discipline across the market.
Importantly, activity within the middle market tells a more constructive story. Increased add-on activity, continued deployment of capital, and steady fundraising (albeit significantly concentrated with larger funds) signals indicate that sponsors are not retreating, but instead adapting – leaning into smaller, more actionable opportunities where conviction remains high and execution risk is more manageable.
While near-term constraints remain, continued activity and operational adaptability in the middle market may help sustain deal flow and provide a foundation for recovery as valuation expectations and capital markets begin to realign.
This material is provided for general informational purposes only and should not be relied upon as accounting, tax, legal, or other professional advice. The views expressed reflect general opinions regarding current market conditions and are subject to change. Information has been sourced from, or informed by, third-party publications including PitchBook, New York Times, Hartford Business and the Financial Times. Please refer to your advisors for specific advice.
© Copyright CBIZ, Inc. All rights reserved. Use of the material contained herein without the express written consent of the firms is prohibited by law. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. Material contained in this publication is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their organization.
“CBIZ” is the brand name under which CBIZ CPAs P.C. and CBIZ, Inc. and its subsidiaries, including CBIZ Advisors, LLC, provide professional services. CBIZ CPAs P.C. and CBIZ, Inc. (and its subsidiaries) practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations, and professional standards. CBIZ CPAs P.C. is a licensed independent CPA firm that provides attest services to its clients. CBIZ, Inc. and its subsidiary entities provide tax, advisory, and consulting services to their clients. CBIZ, Inc. and its subsidiary entities are not licensed CPA firms and, therefore, cannot provide attest services.
