While 2025 may not go down as a blockbuster year for mergers and acquisitions (M&A), the trend is decisively upward.
That may be encouraging news for investors – especially those focused on small-cap stocks – where most of the deal activity is concentrated.
But there are nuances to the M&A trends that need to be considered carefully before making a blanket statement that the trend is good for small-cap investors. Let’s dig in.
Why Is M&A Activity Accelerating?
One key driver is simple: A strong stock market tends to fuel dealmaking. When market returns are solid, companies are more willing to pursue strategic acquisitions. It’s really that simple.
Conversely, in weak markets, deal appetite tends to dry up.
Another factor is valuation. Small-cap stocks remain deeply discounted relative to their large and mega-cap peers. For those of us who track this space closely, that comes as no surprise – small caps in the S&P 600 Index have traded at a valuation discount for years.
Lastly, despite tariff-related volatility earlier this year – especially in April – the policy environment has become less uncertain. That’s helped to unlock deal flow.
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On Pace for a Strong Year
Through October, year-to-date M&A volume is just 5% below 2024’s level. On an annualized basis, this suggests 2025 could be the strongest year for M&A since 2021.
Aggregate deal value is tracking above last year’s levels but remains below the peaks of 2021, 2023, and the five years prior to COVID. The trends point to a continued shift toward smaller, more targeted deals.
Small Caps Are Driving the Action
Much of this year’s M&A activity is happening in small-cap stocks:
- Russell 2000 stocks account for 60% of year-to-date deals.
- Non-index small caps make up 33%.
- Only 7% of deals involve mid-cap stocks.
In other words, if you’re holding small caps, you may already be holding potential acquisition targets – assuming the trend continues.
Which Small-Cap Sectors Are Seeing the Most M&A?
Healthcare leads the pack in 2025, accounting for nearly a third of all deals. According to Bank of America, healthcare M&A is tracking at a 25-year high.
Within healthcare, biotech is red hot with roughly 36 deals – about half of all healthcare transactions. Larger biotech firms, flush with cash and eager to refresh their pipelines, are driving this activity. That’s helped fuel strong performance in biotech stocks, as reflected in the ETFs like the SPDR S&P Biotech ETF (XBI).
Financials rank second, with around 15 deals, mostly among regional banks. While this is a solid showing compared to the past four years, it’s still modest relative to historical deal volume.
Software comes in third, with approximately 14 deals, continuing a steady trend of consolidation in niche verticals.
Does M&A Activity Signal Strong Small-Cap Performance in 2026?
It’s tempting to assume that thriving M&A activity will drive small-cap indices higher. But historically, that hasn’t been the case.
At the index level, small caps don’t consistently outperform during high M&A periods. One reason may be that acquisitions accelerate when small companies are cheap – allowing larger firms to scoop them up at a discount, often using their own stock as currency.
As that valuation discount disappears, M&A activity may slow down since there are fewer “deals” available.
That said, certain sectors do show a correlation between M&A activity and outperformance. Healthcare, tech, and utilities are three that stand out.
If I were to speculate on potential small-cap M&A winners right now, I’d focus on biotech, medical devices, and software. But to be clear, I’d want to own these companies for their fundamentals first – and treat any potential acquisition upside as a bonus.
If you’re looking for specific small-cap stock ideas that could become M&A targets, consider subscribing to Cabot Small-Cap Confidential. You can grab a subscription by clicking here today.
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