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Do Most Family Businesses Really Fail by the Third Generation?

This article was written by an independent media source and selected by LNWM for our blog readers. LNWM provides this third-party information for informational purposes only and has not verified the accuracy or completeness of such. In addition, LNWM is endorsing neither the content nor the author of the commentary.

c.2021 Harvard Business Review. Distributed by The New York Times Licensing Group.

If you’re a fan of the HBO show “Succession,” or if you’re aware of the conflicts playing out publicly and perennially among some of the most visible family businesses in the world, you might assume that family businesses are more fragile than other forms of enterprise. Indeed, that’s the conventional wisdom: Many articles or speeches about family businesses today include a reference to the “three-generation rule,” which says that most don’t survive beyond three generations.

But that perception could not be further from the truth. On average, the data suggest that family businesses last far longer than typical companies do. In fact, today they dominate most lists of the longest-lasting companies in the world, and they’re well-positioned to remain competitive in the 21st century economy.

A SINGLE STUDY, DECADES OLD

Where did that three-generation idea come from? A single 1980s study of manufacturing companies in Illinois. The researchers took a sample of companies and tried to figure out which of them were still operating during the period they studied. They then grouped the companies into thirty-year blocs, roughly representing generations. Only a third of family businesses in this study made it through the second generation, and only 13% made it through the third.

A few observations about that study:

  • First, its core findings are often described incorrectly. Many describe the results to say that only one-third of family businesses make it to the second generation. But the study actually says that one-third make it through the end of the second generation, or sixty years. That’s a thirty-year difference in business longevity.
  • Second, what the study didn’t say is how the company examined compares to other types of companies. A study of twenty-five thousand publicly traded companies from 1950 to 2009 found that on average, they lasted around fifteen years, or not even through one generation. In addition, tenures on the S&P 500 have been getting shorter. The average company that joined the index in 1958 would stay there for 61 years. By 2012, the average tenure was down to 18.
  • Finally, the study provides no insight as to why some businesses disappeared. Family disputes and business problems surely hurt some of them, but in other cases the owners may simply have sold their business and started a new one. That’s far from “failing.”

THE THREE-GENERATIONS MYTH

The three-generation myth is so pervasive that it can become a self-fulfilling prophecy for family businesses who believe the odds of long-term success are stacked against them. That’s what almost happened to one successful business family we advised, which was told by an independent board member that to ensure they survival of their business, they should not hand it down to the next generation.

The siblings cared deeply about their business and the people who worked there. They also very much valued the idea of leaving the business as a legacy for their family rather than cashing out and giving the next generation the proceeds. So when they were ready to retire, they agonized over whether to sell the business to their long-standing nonfamily managers or to pass ownership to the next generation. The board member’s advice had them believing that they had to choose between allowing their company to endure and keeping it in the family. They sensed that this was a false choice, and so they decided to give continued family ownership a try.

It was a wise move: The siblings are well into transferring ownership to the next generation, and the business is thriving with help from nonfamily managers who are bridging the gap between the retiring owners and their successors.

So is there anything to the three-generations myth? Certainly, some families go from rags to riches and back again, but on average, they do not. Those who climb to the top of the wealth ladder tend to stay there for a long time. That’s what Gregory Clark, an economist at University of California, Davis, found when he conducted extensive research on social mobility over generations: Rich families typically stay rich, and poor families stay poor. Eventually there’s a regression to the mean, he wrote, but “the process can take 10 to 15 generations (300 to 450 years).”

In short, even if your family business does fail, there’s little need to worry that the wealth that it has created for you will evaporate.

THINKING IN GENERATIONS, NOT QUARTERS

The longevity of family businesses is important not just to their owners but also to the economy. According to the U.S. Census Bureau, family businesses — companies in which two or more family members exercise control, concurrently or sequentially — represent about 90% of American businesses. Ranging in size from two-person partnerships to Fortune 500 firms, these businesses account for half of the nation’s employment and half of the U.S. gross national product.

Can family businesses continue to be the dominant source of employment nationally and globally over the long term? The answer is yes.

The reason for that is the choices that are made. Rather than being obsessed with hitting quarterly earnings targets, as public companies are, family businesses tend to think in terms of generations, which allows them to take actions that put them in better position to endure the tough times.

For example, Robinson Lumber Company, established in 1893 and based in New Orleans, is today owned and managed by the fifth generation of the founding family. Like many family businesses, Robinson Lumber doesn’t borrow much from the bank. Debt is a great way to fund growth and goose return on equity, but it also puts the company at risk during the inevitable downturns in the economy. Family businesses last longer because they are able to pay the price that longevity requires.

A BRIGHT POST-PANDEMIC FUTURE

Compared to widely held public companies, family businesses tend to thrive when times get tough. The pandemic has provided evidence of this. Though few businesses have been immune to the challenges of the pandemic, family businesses seem to be emerging in better shape than their competitors.

Family ownership brings a competitive advantage in situations that demand resiliency rather than rapid growth. That means working hard not only to preserve cash but also to ensure the well-being of employees and communities. In many studies, family companies have been shown to be better employers and community citizens than their nonfamily-run peers. That’s a distinct competitive advantage, one that represents capitalism at its best.

c.2021 Harvard Business Review. Distributed by The New York Times Licensing Group.