A growing divide is emerging in the lower middle market as private equity investors reassess what makes a business durable in the age of artificial intelligence.
Firms that once chased asset-light, software-driven growth are increasingly turning their attention to companies with physical infrastructure, operational complexity and steady demand. The shift reflects a broader recalibration underway across dealmaking, where the rapid advancement of AI is forcing investors to reconsider long-held assumptions about competitive advantage.
Align Business Advisory Services Chief Executive Dena Jalbert said the trend is particularly pronounced in the lower middle market, where buyers are scrutinizing not just growth potential but the risk of technological displacement.
“The shift toward HALO-type businesses is largely a reaction to the uncertainty around how quickly AI is compressing differentiation in software and tech-enabled models,” Jalbert said, referring to sectors defined by heavy assets and low obsolescence.
A New Premium on Durability
For years, private equity firms favored asset-light businesses that could scale quickly with limited capital investment. But the same characteristics that once made those companies attractive—speed, flexibility and reliance on software—are now raising new questions.
Tools powered by AI have reduced the barriers to entry in many technology-driven industries, making it easier for competitors to replicate products and services. In some cases, what once required years of development can now be built in a matter of months or even weeks.
That dynamic is pushing investors toward businesses that are harder to replicate.
Companies with physical assets, embedded demand and operational depth are increasingly viewed as more resilient. These include manufacturers, infrastructure-related businesses and service providers with significant logistical or regulatory complexity.
Such businesses can still benefit from AI, but they are less likely to be displaced by it. “Investors aren’t moving away from tech,” Jalbert said. “But they’re prioritizing businesses where technology supports the model, rather than being the entire moat.”
Redefining Defensibility
The shift is also changing how investors define defensibility, a cornerstone concept in private equity underwriting.
Historically, proprietary technology or intellectual property often served as a company’s primary barrier to competition. Today, that advantage appears less durable.
“An app can now be built overnight, but a factory can’t,” Jalbert said.
Instead, investors are placing greater weight on factors that are harder to replicate, including long-standing customer relationships, regulatory barriers, operational expertise and the ability to execute consistently at scale.
The central question, she said, has become more direct: How quickly could this business be disrupted, automated or commoditized—and by whom?
Companies that can demonstrate resilience against those threats are commanding greater interest, even if their growth profiles are more modest than high-flying technology startups of prior years.
A Market Dividing in Two
The result is a growing bifurcation in valuations across the lower middle market.
Businesses perceived as vulnerable to AI disruption are facing increased scrutiny. Deal timelines are lengthening as buyers conduct deeper diligence, and in some cases, valuations are coming under pressure.
The distinction is not strictly sector-based. Rather, it hinges on how integral AI is to the company’s core value proposition—and whether that value could be replicated or replaced.
At the same time, companies with physical infrastructure, recurring revenue and operational complexity are drawing strong demand. Buyers are increasingly willing to pay a premium for predictability and durability, particularly when there is a clear path to scaling the business or expanding margins.
The divergence underscores how quickly investor preferences are shifting, as technological change reshapes risk calculations across industries.
What Founders Need to Show
For business owners considering a sale, the changing landscape is altering how companies must position themselves.
Founders can no longer rely solely on growth narratives or technology differentiation. Instead, they must clearly articulate why their businesses are built to last.
That includes demonstrating operational strength, consistency and the ability to scale systems over time. Even in asset-heavy sectors, investors expect to see thoughtful integration of technology, including AI, to improve efficiency, decision-making and customer experience.
“The strongest outcomes come from companies that have been intentional about their positioning well before they go to market,” Jalbert said.
In practice, that means telling a more complete story—one that highlights not just what a business does today, but why it is structurally positioned to adapt as technology continues to evolve.
As AI accelerates change across industries, investors appear to be rediscovering an old principle: In uncertain times, the hardest things to replicate often become the most valuable.
