From Attorney Dr Johannes Baier, RA Viktor Amadé Baron and Charlotte Seltenreich
Professional services and private equity are no strangers to each other. In the search for profitable sectors with development potential, private equity (PE) already invested in engineering companies and architecture firms years ago and supported their high-margin activities with PE expertise.
Over the past year, the law firms of auditors, tax advisors and lawyers have increasingly become the focus of investment attention as new targets in the DACH region. The investment story here is the same: Consolidate and modernise asset-light businesses with staff-dependent scalability - at best with AI catalysis - and raise them to a new level of efficiency and structure with PE experience. The growth potential and the opportunities of a double-digit growth market speak for themselves.
In the following, we provide an overview of our daily practice in this regard and organise the loose ends.
Regulatory principles
According to the so-called prohibition of third-party ownership, there may be no pure equity investments in law firms and tax advisory firms. A similar principle also applies to auditors, albeit in a slightly adapted form. With regard to lawyers, the ECJ ruled (more below) that professional independence - as an essential reason in the public interest - is incompatible with the profit-making intention of a pure (capital) investor. The extent to which this decision applies to tax advisors and auditors is currently still unclear. Just as Section 59i (3) of the Federal Lawyers' Act (BRAO) stipulates that only lawyers can be shareholders in a law firm, this is regulated for auditors by Section 28 (4) of the Auditors' Code (WPO) and for tax consultants by Section 55a (3) of the Tax Consultancy Act (StBerG). These provisions are intended to prevent (financial) investors from acquiring a majority stake in professional practice firms. Professional practice companies are companies in which (1) members of the liberal professions join together to practise their liberal profession (tax consultants, auditors, lawyers, etc.) and (2) the respective chamber responsible for the liberal profession (Chamber of Tax Consultants, Chamber of Lawyers and Chamber of Auditors) has granted recognition as a professional practice company. The aim of the standards is to safeguard the independence and integrity of these liberal professions.
ECJ decision on the prohibition of third-party ownership for lawyers
With regard to law firms, however, investors were initially prevented from making a direct investment. The European Court of Justice (ECJ) (decision of 19 December 2024, case C-295/23) confirmed the prohibition on third-party ownership stipulated under German law. Specifically, the ECJ clarified in its decision that the ban on pure (PE) investors holding shares in law firms is both permissible and justified by member state regulations - in this case, the relevant Section 59e BRAO under the former german law - in order to guarantee the independence of lawyers. The independence of lawyers is an essential prerequisite for the proper exercise of the legal profession and thus for the functioning of the rule of law. EU law, in particular the free movement of capital, the services directive and the fundamental freedoms, did not preclude the national regulation either. A member state - in this case Germany - could assume with good reason that a lawyer would not be able to practise his/her profession independently if he/she belonged to a firm in which (legal) persons with purely financial interests were involved as shareholders. The regular motivation of investors, namely profit maximisation, would in principle conflict with the activities of a lawyer. The prohibition of third-party ownership is also not disproportionate, as it essentially serves the telos of ensuring the independence and quality of legal advice.
Quo vadis PE?
The case decided by the ECJ concerned the transfer of the majority of shares in a German law firm entity to an Austrian limited liability company, which pursued (purely) economic interests, i.e. the overriding interests as in the case of investments by PE funds in professional service companies. As it is clear - now also confirmed by the ECJ - that the direct acquisition of German law firms, tax advisory and auditing firms should not be permitted for the time being, alternative strategies must be used.
EU holding
A professional service holding entity from other European countries has already received a lot of press coverage. The connecting factor here is that auditors and tax advisors from other European countries can invest in German professional practice companies. Accordingly, a financial investor first acquires a stake in a foreign EU consulting entity, which in turn acquires the shares in the German consulting firm. According to Section 55a (1) No. 3 StBerG, recognised auditing firms may be shareholders in a professional practice entity. Section 28 (1) sentence 2 WPO also allows a recognised EU/EEA audit firm to acquire a stake in an audit firm. For these EU/EEA audit firms, the state of origin principle applies, which does not require compliance with the requirements of the German WPO. This means that if the state of origin permits equity investments in professional service firms, an indirect investment in a German professional practice firm can be structured in this way. Finally, the WPO does not stipulate that the parent company of an audit firm must have its registered office in Germany. This model is already being used by several investors in various service areas, as can be read in the press. However, this concept only works for auditing and tax consulting firms, as only freelancers themselves or law firms are allowed to participate in law firms.
Succession financing by an investor
Another way for an investor to participate (indirectly) is to finance the "succession plan" of the shareholders. In this case, the investor does not become a direct or indirect shareholder, nor does a subsidiary acquire shares in the German tax consultancy or auditing company. Rather, the investor finances the takeover of shares of the departing founder/shareholder of the company by incoming successors (Private equity enters the tax consultancy business through the back door, Börsen-Zeitung, 21 February 2025). This financing enabled several senior managers to acquire a majority stake in the company, with the financing being provided by an external third party. The financing does not violate the prohibition on third-party ownership, as the investor itself does not acquire any shares in the company. In addition, the managers joining the company may not hold the acquired shares on behalf of the investor. The latter would in turn constitute a violation of the prohibition on third-party ownership. This is a type of management buy-in (MBI). In this constellation, however, the PE has far less influence than with a direct participation solution.
The challenges
However, both the EU holding constellation and the "financed succession" are by no means a sure-fire success and do not appear to be entirely satisfactory. Of course, from a PE perspective, it would be desirable for European legislation to be more open to investment and for the diversions via an EU holding company to simply no longer be necessary. In the US, the consulting market has been consolidating for some years now - particularly under the strong influence of PE. The homework, to be done is as follows:
- The judgement of the ECJ was a damper;
- with regard to the EU holding company solution, it remains to be seen how the regulatory framework in Europe and Germany will develop;
- the ECJ's decision has been widely supported in the legal literature and celebrated as a victory against foreign investment, especially by professional associations; it would not be surprising if legislation in Germany were to take a more protectionist path;
- in the meantime, the practical problem has arisen that the previously favoured Luxembourg audit holding is simply running out of auditors required for the acquisition company level;
- it is a matter of time before the respective professional chambers form an official opinion on the EU holding practice; a review of the supervisory bodies is probably only a matter of time;
- with regard to indirect successor financing, it is clear that the MBI candidate naturally pursues, or must pursue, the interests of the investors behind and, from a PE perspective, the complexity of the investment should not be neglected, because the exit at the end of the holding period by selling the holding company is not as trivial in a dispersed MBI structure as in the usual secondaries when selling the platform parent entity or its holding company;
- in most cases, the primary target companies are categorised as micro-cap companies, which is why they are ideally suited as an extension of the group (add-ons); at the same time, this also makes the implementation of the acquisition strategy very granular;
- the biggest lever is also the most challenging task in post-merger integration, because when groups with four-digit employee numbers are acquired in a sector that is still technologically underdeveloped, the integration strategy must also include a redundancy plan.
Road to Glory
The challenges listed are not deal breakers. Operationally, the key levers are personnel and technology. From an investor's perspective, it is therefore important to offer the right solutions now for the primary set-up of the platform, which is then exit-ready, in particular:
- the governance of the group should be clearly defined, there should not be too many cooks spoiling the broth;
- technological developments must go hand in hand with personnel development;
- the right market shares must be allocated to the company's own platform as part of the buy-and-build strategy.
Conclusion
Professional regulation, in particular the ban on third-party ownership, poses challenges for PE when it comes to investing in law firms and companies regulated under professional law service. However, there are plenty of opportunities for investors to participate in the positive development of the advisory business and the very good profit margins. In any case, the constellations already published still leave considerable uncertainties unanswered. Creativity in terms of organisation is and should go much further than an EU holding company or an MBI. After all, there are only a few markets with double-digit growth potential. An understanding of the legal framework and a precise adaptation of investment strategies are crucial in order to successfully utilise the opportunities in the business services sector.