Do Most Family Businesses Really Fail by the Third Generation?

Even in the current age of tech & digital, the dominant form taken by private sector enterprise is the family run business rather than listed businesses. Both in India and in the US such family run businesses account for the vast majority of the nation’s employment: “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 percent 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.” Therefore, the health of this institution of private sector enterprise should be a matter of national interest.
 
In most countries there is a perception that family run businesses are fold up within three generations of being created i.e. the founder’s grandchildren turn out to be not quite upto the mark and thus things fall apart. This HBR article uses a data driven approach to debunk this urban myth: “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…”
 
The article begins by highlighting an old study which is supposedly the root source of the three-generation myth: “A single 1980s study of manufacturing companies in Illinois. That study is the basis for most of the facts cited about the longevity of family businesses. 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.”
 
The authors of the HBR piece then explain why the 1980s study has been misinterpreted. Whilst doing so they give a chilling statistic about publicly listed companies in the US: “…tenures on the S&P 500 have been getting shorter. If the average company joined the index in 1958, it would stay there for sixty-one years. By 2012, the average tenure was down to eighteen years. A Boston Consulting Group analysis in 2015 found that public companies in the United States faced a five-year “exit risk” of 32%, meaning that almost a third would disappear in the next five years. That risk compares with the 5% risk that public companies faced in 1965.”
 
Then the authors pivot the piece in an interesting direction by citing research on how rich people stay rich and this is true the world over, not just in the US: “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).” Similarly, when economists from the Bank of Italy studied tax records in Florence in 1427 and 2011, they found that today’s top earners were “already at the top of the socioeconomic ladder six centuries ago.””
 
The authors then go on to use case studies and a survey done across 140 countries to illustrate that family run businesses are emerging from Covid-19 stronger, not weaker, than their publicly listed counterparts: “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.
In December of 2020, we surveyed family businesses all around the globe (140 respondents from five continents representing more than 25 industries) and found an optimism that they not only had weathered the worst but an expectation that they will gain ground in the months ahead. Sixty-eight percent of those surveyed believe that they will have more efficient operations when the pandemic is over. And more than half believe there will be new business opportunities, more efficient decision-making processes, and learning opportunities for the next generation. Even at the height of the pandemic, a full 25% of those surveyed believed that their market share would not only survive but increase in the years ahead.”

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Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.