Challenging The Three Generation Rule

If you’re a fan of the television 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 — think the Murdochs or Sumner Redstone’s family— 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, according to BanyanGlobal’s Josh Baron and Rob Lachenauer, who carefully walk through what the data really tells us about the success rate of family businesses over generations.

The oft-repeated 3 Generation Rule, Baron and Lachenauer argue, is misleading. The data suggests that, on average, family businesses last far longer than a typical public company does. Far from being doomed to failure, family businesses across the world will continue to be a leading source of jobs and economic growth for years to come. 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.

Where did that three-generation idea come from? 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.

But when you look closely at the study, you might see things a bit differently. First, its core findings are often described incorrectly. When people talk about the 3 Generation Rule, they suggest that this study reveals 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! Not the same thing at all.

Second, Baron and Lachenauer point out, what the study didn’t say is how that compares to other types of companies. The comparison, it turns out, is actually quite favourable for family businesses. 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. 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.

Finally, the study provides no insight on why some businesses disappeared. Family disputes and business problems surely did 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.’

You can read the full article by BanyanGlobal’s Josh Baron and Rob Lachenauer here