Skip to content

The Third Generation: Will They Destroy it or Grow it?

Managing the Family Business for Multigenerational Longevity

House of NepotismIntroduction

This question, to say the least, this can be a vexing issue when it relates to your own grandchildren.The basic recipe for a healthy family business is to maintain family unity while growing assets, carefully managing lifestyle expenditures, and having the right talent in important roles.

The reverse of those behaviours – disunity, shrinking assets, unrestrained spending, and unsuitable talent – are the most powerful forces that destroy family businesses, bringing down the vast majority by the time they’re in the hands of the second and third generation. Amongst these is the power that unrestrained nepotism can contribute to the demise of a family business.

Generally, family businesses perform better than non-family businesses. However, only around 30 per cent survive to the third generation with the original family still in ownership. More disturbingly, only about 15 per cent make it into the fourth generation. Most end in failure or are sold off.

Why Families Lose Their Wealth

Do you know why the heirs of successful business owners often oversee the demise of the business and evaporation of family wealth?

Historically, it starts with the second generation who get wealthy from the profits of the family’s already successful operating company. For two-thirds of these companies, this is when wealth starts to slide gradually; for one fifth, it will end in a crash.

There are a number of reasons for the fast decline of wealth which we see in 20 percent of families: economic depressions, disaster and disruption (making their product obsolete). Additionally, there are ‘big, bad bets’, with someone wanting to prove their business brilliance and betting on a venture about which they’re misinformed. FACT:  Families are terrible at pulling the plug on bad investments, so they’ll often double down on bad bets, much to the detriment of their wealth position.

BUT – it’s the third generation that can really make a mess of things. And that is acknowledged across many cultures in oft-repeated sayings, such as Mexico’s “padre-bodeguero, hijo-millionario, nieto-pordiosero” (father-merchant, son-millionaire, grandson-beggar).

By the time the third generation takes over a family business, if the family is not on the right path, its return on assets decline just as the family is getting bigger and their lifestyle needs are increasing. This leads to the family consuming its own assets.

At the pinnacle (when family wealth just starts to edge off its peak), you don’t really know it’s going down. When the decline in wealth gets serious someone should sound the alarm: ‘let’s change what we’re doing’. But families don’t change quickly or easily (well, some do and they grow, but that’s not often).

So why doesn’t someone put on the brakes? Because families like equilibrium – in other words – the way things are. Hence, if they can’t agree on what to do, they stay stuck on the downward trajectory. Families can fracture more as their wealth deteriorates, with some members demanding “give me my share of the money”.

Resisting transformation and change

One dangerous flaw in family businesses is when the family is too focused on the company’s operations and not focused enough on trends in their industry and in adjacent industries. Family businesses working toward operational excellence but losing site of the changing market they’re in is a common error.

Connected to this is a natural inclination of families to be traditionally minded in the product or service the business offers and where it’s located. Such businesses can put themselves at a serious disadvantage by taking too long to become aware of changing trends that are making their products obsolete or their place of manufacturing unaffordable.

Families are historically very good at what they do – growing within their industry. However, as a family business owner, you’ve got to get better at looking outside your company and industry.

Relatedly, families are often reluctant to address poor performance of business managers and employees. Sometimes this extends to the Chief Executive Officer of the business.

CEO’s in today’s corporate world generally stay in office for about five years. However, in family businesses they tend to stay on for an average of 25 years.

An issue with a Chief Executive staying in office for so long is that markets are ever-changing, radically, requiring businesses to transform up to two to three times, or more in a 25-year period. For one CEO to manage such transformations successfully over such a period is a rarity.

How Families Grow Their Wealth

A simple formula for growing your wealth over generations is three-fold:

Unity and talent in the family are essential

Be sure to invest in unity consistently. You want a family and shareholder group that is united and creates value. Being united and aligned means that you will be better off.

Families stay in business when members are disciplined, united and contributing in some manner to the business. It’s this factor that has seen some European families successfully pass their businesses onto the fourth, fifth and sixth generations and beyond!

This emphasis on unity and talent must extend across three groups of people involved in the family business. These are the:

  1. Ownership group (which can sometimes include parties outside the family)
  2. Business employees (both its executive leadership and employees)
  3. Family (the ‘business family’ which is connected through ownership, meaning the current owners, their spouses and their immediate descendants).

It’s vital that you pay attention to the development of unity and talent in all three groups. It’s a formula, a three-circle system. Different interests must be aligned, such as those of employees and family owners.

When there is discord, there are differing visions and alternative expectations of how the business should operate. Then conflict can intensify between these groups, thereby destabilising the business.

One effective way to build unity is to agree on what your family is fundamentally trying to accomplish, that is, “your family mission”. Further to this, it’s important to put the right talent in the right roles using objective criteria and a fair, transparent process for selecting them. Develop the skills of key members (family and non-family) across the business, the board of directors, and in ownership.

Develop people in your family for roles well suited to them. This will build unity and lead to trust, not to mention boost productivity.

By focusing on talent development, it will become clear that it’s essential to invite non-family members to join management, leadership, board, and advisory positions so that people with the right skills are in the right places, running the business and growing wealth.

Growing families can easily consume the wealth being created, especially as company growth plateaus. You need people who know how to make money – hire them if your family can’t do it themselves.

Staying on the Forbes Wealthiest List

A recent study, encompassing an entire generation, showed that, of the 320 families on the Forbes wealthiest list in 1989, two thirds fell off the list by 2011. Of the 103 that remained, their net wealth compounded over those 30 years, growing approximately 6 per cent a year to double their assets every 10 years.

Notably, those that stayed on the wealthiest list was because their wealth stayed in their operating companies. They didn’t sell and passively bank the assets. While their businesses may have changed over time, they still owned and operated the company. The returns of an efficiently run operating company are better than wealth being put solely into passive investments.

These families maintained successful operating companies for such a long period by making sure good leadership and good structures were in place. It was also attributed to the factor of ensuring that the right resources were available so that the business could focus on growth. They held on to the right talent and developed or brought in the talent they needed. So, company and family unity was maintained.

Summary

We hope that by now, you have a much better understanding of what successful multigenerational longevity for a family business entails. If you’re still having trouble making sense of all the information we’ve given you here, we encourage you to talk with an experienced estate planning adviser about how they can help you achieve your succession planning objectives.

For further reference and insights, check out our preceding article on Wealth Transfer Challenges.

How FBA Can Help You With Your Family Business Management

At Family Business Advisory (FBA), our purpose is to help family businesses succeed on a sustainable basis. As such, we provide you with access to specialist family, business and technical services with a goal being to generate opportunities for families in business.

In order to complement our own particular specialised skills, over the past several decades, we have developed a network of trusted, professional advisers in such areas as:

Image of Services spectrum

Moreover, we work at all times to give you peace of mind and proactive support to help navigate any changes in the market brought about by legislative changes, geopolitical events and general market conditions – all to maximise your personal wealth and security.

These services are provided by FBA, in association with the Wealth IQ Group.

Book an Appointment

Contact Us

Get in touch now to discuss other financial matters:

Discover more from Family Business Advisory

Subscribe now to keep reading and get access to the full archive.

Continue reading