The third generation rule is the commonly cited notion suggesting most family businesses don’t survive beyond the third generation. Josh Baron and Rob Lachenauer, writing for Harvard Business Review in an article posted July 19, 2021, performed extensive research and shared convincing arguments that this “rule” is a myth without statistical or historical proof.
It was revealed that the original third generation rule came from a single study done in the 1980s of manufacturing companies in Illinois. That study provided the basis for most of the facts cited about the longevity of family businesses. The 1980s 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 30-year blocs, roughly representing different generations. Only a third of family businesses in this study made it through the second generation, and only 13% made it through the third.
Baron and Lachenauer reveal that the core findings of those researchers are often described incorrectly. In reality, the study showed that one-third of the businesses actually make it through the end of the second generation, or 60 years, rather than the belief that only one-third make it into the second generation. Potentially, that’s a survival time of an additional 30 years.
They also state that the original study did not provide comparisons to publicly traded companies. When the authors reviewed the information of 25,000 publicly traded companies from 1950 to 2009, these comparison companies lasted an average of 15 years, or not even through one generation.
Additionally, the 1980s study provides no comparative information on why some businesses disappeared. There is the possibility that many of the businesses were successful but sold by the owner because there was no heir that wanted to continue the business. Family disputes and business problems surely did hurt some of them, but in other cases the owners may simply have sold their business because they wanted to start a new one or invest the money from the sale of their successful business into a different one. That’s far from “failing.”
The Harvard Business Review article provides several examples of how family-owned businesses are much more likely to survive for multiple generations compared to a similar time frame for non-family corporations. “In fact,” the researchers state, “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.”
One key fact is that family businesses make financial decisions for steady growth, while publicly held companies must provide quarterly reports to their shareholders and show consistent profitability or risk investors selling their stock for something more profitable.
Family businesses are much more cautious about taking on debt, and they tend to do whatever it takes to keep the business running in difficult times. They will put in the extra hours, delay planned capital investments, postpone personal expenses and personal plans, and shift all their efforts toward getting back on track as soon as possible.
What this means
If we consider this myth “busted,” what does it mean to the tens of thousands of family businesses in the country who want to be sure their business lasts for multiple generations? Here are a few considerations:
- Appreciate that you are doing a better job of keeping your business profitable than most of the publicly traded companies on the S&P – and share this with your children to boost their confidence.
- Use this as an opportunity to teach the next generation the unique capabilities of family businesses and their ability to survive difficult times.
- Spend significant time sharing about your hard times in the past and the difficult times of the generations before you. Consider having the elder generation share their experiences, including the key lessons they learned and the mistakes they made along the way. Life’s too short to only learn by our own mistakes. We also need to learn from the mistakes of others.
- Help the next generation realize the statistical probabilities for their success are not determined by anecdotes and old wives’ tales. It is the result of their personal devotion to great management, overcoming any challenge and making sacrifices that show they choose delayed gratification over immediate pleasure.
The value of family businesses
If you’re aware of the conflicts playing out among some of the most visible family businesses, perhaps businesses we only hear about because of their conflicts, you might assume that family businesses are more fragile than other forms of enterprise.
However, that perception could not be further from the truth. On average, the data suggest that family businesses last far longer than typical companies. 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.
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 (where 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.
Family ownership brings a competitive advantage in situations that require devotion and hard work rather than rapid growth. Family businesses, with owners who are extremely close to the day-to-day activities of the business, can adapt quickly to changing circumstance and balance the challenges of navigating through the current crisis with the implications for the long term in mind. When revenues are down, these businesses work hard not only to preserve cash but also to ensure the well-being of employees and communities.
Many family businesses are considered the “Employer of Choice” in their local area because of their desire to provide long-term jobs for their employees and their personal devotion to their employees’ families. Their children go to the same schools, worship at church together, shop in the same stores, attend each other’s birthday parties and live life together.
Each generation of a family business has its own lessons to learn and obstacles to overcome. Let’s stop telling the third generation that they are “more likely to fail.”
