ESOP Market Outlook for 2025: A Promising Year for Formation and Growth

Employee ownership is set to thrive in 2025, with bipartisan support and growing national attention. Businesses are positioned to capitalize on a period of economic growth, making it an ideal time to establish or grow an ESOP. Changes in fiscal policies could further benefit employee ownership by creating opportunities to maximize valuations. Additionally, strong capital availability will make 2025 a supportive environment for ESOPs looking to raise funds for expansion. The momentum for employee ownership continues to build, offering both stability and opportunity for business owners and employees alike.

Read on to explore the important economic indicators from 2024 and how they’re expected to drive the improving market environment for ESOPs in 2025.

As an additional resource, you can download our Financial Market Pocket Guide, which lists key economic variables and their impact on valuation year-over-year.

2024 Recap: A Year of Stability and Recovery

Key economic milestones and their implications.

Despite the 2024 presidential election and continuing geopolitical pressure, financial markets registered a year of continued stabilization and recovery. Unlike in 2022 and 2023, when we experienced headline inflation and the regional banking crisis that began with the collapse of Silicon Valley Bank, 2024 was free from catastrophic economic events—which was great news if you follow the equity markets.

Inflation maintained its downward trajectory, moving closer to the Federal Reserve’s 2 percent target, which allowed for a more accommodative monetary policy in the latter half of the year. A strong labor market supported steady growth, while robust activity in the investment-grade debt capital markets signaled growing confidence in the broader financial market. The Fed’s decision to cut interest rates, combined with strong corporate earnings and healthy consumer spending, helped the S&P 500 achieve its best two-year return in more than 25 years.[1]

But what do these headlines mean for ESOP companies?

Inflation: Tamed Expectations, Elevated Opportunities

Why consistent inflation rates enhance financial forecasting and investment opportunities for ESOPs.

After dominating the economic landscape since 2021, inflation has receded considerably, continuing its downward trajectory throughout 2024 after several years of aggressive monetary tightening. In the second half of the year, the Federal Reserve began making rate cuts for the first time since the beginning of the COVID-19 pandemic, before tempering this effort at year-end as inflation measurements increased slightly. In its December meeting, the Fed reduced the federal funds rate by 25 basis points, setting the target range between 4.25 percent and 4.50 percent (see the graph below). Furthermore, the Fed’s new median rate projection for 2025 signals two additional interest rate cuts.[2]

Inflation and inflation expectations are inherent in every financial analysis and important for ESOP valuations and capital allocation decisions. Since September 2022, inflation expectations have settled between 2.0 percent and 2.5 percent (as demonstrated in the graph below), generating a sense of consistency that creates opportunities for more precise financial forecasting and greater confidence among those making capital allocation decisions.

Companies typically prepare financial forecasts on a nominal basis (i.e., nominal growth = real growth plus inflation), which should reflect the expected inflation rate. Given the lower and more consistent inflation expectations, reviewing short- and long-term growth rates is a wise approach for those looking to form or grow an ESOP.

Interest Rates and Capital Costs

How lower borrowing costs and a favorable yield curve benefit ESOP transactions.

If you’re looking to form or grow an ESOP in 2025, another important indicator is the Treasury yield curve (depicted in the graph below). Considered “risk-free,” Treasury rates are the building blocks for establishing required rates of return for investors. The yield curve was inverted throughout the first half of 2024, meaning short-term rates had higher yields than longer-term rates. The yield curve implied market participants expected rates to decrease in the future.

For a simple example of how the Treasury rates impact the “reference rates”, let’s focus on three rates (a short term Treasury bill, a medium term Treasury note, and a long-term Treasury bond):

Debt Markets: Favorable Trends for ESOPs

Cheaper debt and improved bank lending provide growth opportunities.

When looking to form or grow an ESOP, let’s focus on four specific takeaways from debt capital markets. First, the Secured Overnight Financing Rate (SOFR) decreased 89 basis points in 2024, consistent with the movement in short-term Treasuries and generally in line with the Fed’s target rate. This implies a lower cost of floating-rate debt.

Second, credit spreads on corporate debt have decreased to their lowest levels since the 1990s. In other words, corporations are paying the lowest premium on investment-grade debt this century. Taking advantage of this trend, investment-grade rated companies raised $1.52 trillion last year, a 26 percent increase over the $1.21 trillion issued in 2023, making 2024 the second-most prolific year on record.[3] The implication for ESOPs: debt is cheaper now, relative to risk-free investments, than at any other time in recent history.

Third, despite the decrease in the corporate spread, the cost of Baa debt increased from 5.49 percent at the end of 2023 to 6.00 percent at the end of 2024.[4] From a valuation perspective, the cost of debt is a component of the weighted average cost of capital. All else being equal, when using the income approach, an increase in the cost of debt will result in a lower valuation indication. Depending on the valuation, your company’s cost of borrowing or a market rate may be applied.

Finally, bank balance sheets have improved, and lending standards have normalized following the regional bank crisis (starting with the collapse of Silicon Valley Bank) in early 2023. We anticipate senior lenders will be more active in 2025 than in the previous two years, in both the number of opportunities they pursue and the amount of capital they are comfortable lending. This will lead to more capital available for forming ESOPs or for growing existing ESOP companies.

Equity Markets: Middle-Market Insights for ESOP Companies

Beyond the headlines—what valuation trends mean for smaller companies.

Regarding valuation, ESOP companies may be in for a surprise. The headline market return for 2024 was strong, with the S&P 500 achieving a 23.3 percent gain in 2024, following a 24.2 percent increase in 2023—marking the index’s best two-year performance since 1997-1998. Due to the size of companies and the market-weighting structure in the S&P 500, however, the index’s return isn’t representative of most ESOP companies. Indeed, the so-called Magnificent Seven (Meta, Alphabet, Tesla, Nvidia, Apple, Amazon, and Microsoft) have an outsized impact on the S&P 500.

We find that the S&P 600 index, which includes companies with market caps of $250 million to $1.2 billion across various sectors, is more indicative of middle-market performance. The S&P 600 finished with a 6.8 percent gain in 2024 (see graph below).[5]

Valuation multiples are another relevant indicator for ESOPs. From December 31, 2023, to December 31, 2024, the trailing 12-month (TTM) EBITDA multiple expanded from 15.4x to 17.4x for the S&P 500 and from 11.6x to 12.0x for the S&P 600. Multiples for the S&P 500 and S&P 600 have increased by 39.3 percent and 30.8 percent, respectively, since 2022 (see graph below).

M&A activity also experienced a resurgence in 2024, rebounding from the slowdown observed in 2023. Increased deal volumes, particularly in the technology and healthcare sectors, have been driven by strategic consolidations and the pursuit of innovation, with valuations in the middle market holding steady. Sitting on an estimated $2 trillion in dry powder,[6] private equity firms are well positioned to contribute significant deal volume in 2025. Analysts anticipate continued momentum in M&A activity, with companies leveraging deals to enhance growth and competitiveness in an evolving market landscape.

The cost of equity has marginally increased, with a decrease in the equity risk premium offsetting the increase in the risk-free rate. These inputs will impact your ESOP valuation, whether it’s for a new ESOP, an annual update, or a potential merger or acquisition.

Looking Ahead: Strategic Moves for 2025

Key considerations for companies navigating the ESOP landscape this year.

As we navigate 2025, businesses are poised to capitalize on a period of economic growth and evolving fiscal policies. Lower short-term interest rates may provide opportunities for debt restructuring. Additionally, fiscal policy changes under the new administration may further bolster company valuations, with potential tax rate reductions enhancing after-tax profitability and encouraging investment in technological advancements or strategic acquisitions.

Now is an opportune time to review and revise your company’s approach to cash, debt, and investment decisions. Here are several considerations:

• Returns on cash are still available. Investing in short-term instruments like money market funds can provide liquidity and yield.
• Debt is relatively cheap. Although the overall cost of debt is higher than the rates experienced prior to the spike in inflation in 2022, the current cost of debt is at lows relative to the returns available on other investments. Ensure your capital allocation strategy reflects current available returns.
• Existing ESOPs – Review your repurchase obligation. In light of recent positive market trends, confirm that your share repurchase commitments align with your company’s financial strategy, and determine whether lump-sum payments or installment payments are beneficial to the company. Also, evaluate whether it is a good time to purchase shares from departed ESOP participants.
  
  

ESOPs Positioned for Success in 2025

Strong bipartisan support and market dynamics signal a bright future.

We anticipate that 2025 will be a strong year for ESOPs. The market continuity experienced in 2024 (an election year) bodes well for 2025, as does the relative decrease in the cost of debt. So long as valuation multiples remain flat and M&A stays competitive, all signs point to improved profitability, favorable market conditions, and share price appreciation for your ESOP.

[1] Nasdaq: 2024 Review and 2025 Outlook, January 2025.

[2] FOMC: Summary of Economic Projections, December 2024.

[3] Reuters: “U.S. Companies Rush to Bond Market in Fundraising Flurry,” January 2025.

[4] S&P Capital IQ

[5] S&P Capital IQ

[6] Corporate Board Member: The Outlook for M&A in 2025, December 2024.