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Beating the Third Generation Curse

Oct 22 – 26. 2018

German immigrant Bernhard Stroh came to America in 1849 armed with little more than a recipe for making beer. The beer was so popular that he set up a brewery shortly before the First World War. By 1980 it had grown to become America’s third largest beer company. At its height in the 1980s, the Stroh family’s wealth was estimated at $9 billion by Forbes. It was all lost by the early 2000s.

In her book, Beer Money: A Memoir of Privilege and Loss, Frances Stroh recounts all the bad investments, missed opportunities, lavish purchases and failed ventures that eroded the family’s immense fortune.

“I heard from all kinds of people about lost fortunes, lost businesses, often coupled with substance abuse issues within the families,” she told The New York Times in an interview after the book became a bestseller. “My story resonated with their own experience because of this lingering sort of sense of something that’s unresolved when a family business is lost.”

Squandered family wealth is far from uncommon. In fact, most families lose the core business and greatly diminish resources by the third generation. An article in the Harvard Business Review estimated that less than 10% of family businesses survived into the third generation.

Some of the most high profile families that have lost substantial amounts of wealth by the third or fourth generation include the Vanderbilts, Hartfords, Kluges and Pulitzers. In most of these cases, the bulk of family wealth was created and squandered within the same century.

Entrepreneurs and founders seem to recognize the so-called “third generation curse” but often struggle to adequately plan for it. “I would say that families are very aware of the third generation curse, but most families tend to think the chances are remote,” says Ivan Hernandez, co-founder and managing director of Omnia Family Wealth based in Aventura, Florida.

“It’s very similar to how people assume winning the lottery fixes all your financial woes, yet 70% of lottery winners go broke within seven years. Only once you see that these actually are real issues that can impact your family can you truly address the forces that are most destructive to multi-generational wealth.”

Judy Lin Walsh, principal at Boston-based family advisory BanyanGlobal, believes a lack of communication is often the most destructive of these forces. “Communication is always key,” she says.

Open conversations about the family’s wealth, the structure of the business, and the ambitions of the founder are important, but Walsh believes founders need to do more than just tell stories. They need to pass on life lessons and help the next generation appreciate the hard work that created their good fortune.

This conversation may also be able to bridge the gap between first and third generation members of a family. However, grandparents may need a different strategy when trying to engage the youngest generation.

“Communications with the grandchildren will have to be at a different level. Instead of trying to communicate operational details about the company or the go-forward strategy, a founder should seek to communicate life lessons that showcase the successes and struggles he experienced as he built the enterprise,” says Walsh.

“Most stories about founders are heroic stories of stunning business victories. Equally important to hear are stories of strife or failure – what the founder learned and how he or she rebounded. Those are the more important lessons to communicate with future generations if you want them to be bold, to strive, and to be resilient.”

Walsh believes the failures and flaws of the founder often get airbrushed over time and replaced with a larger-than-life mythos. Successive generations of the family need to understand the values and lessons that drove the founder to success instead of being crushed by the expectations of a monumental success story.

“Founders start from nothing and create something. Their values are born from their lives,” she says. “You can’t replicate those life experiences in subsequent generations, but you can make the memory of a founder three-dimensional.” Walsh believes families should regularly discuss different life lessons and values that helped the founder succeed.

Hernandez agrees. “Regularly held family meetings are a great way to create a safe space and structure to discuss the family’s wealth and the values that helped build that wealth,” he says.

The binding force that allows this communication to flow freely is often a shared endeavor, such as charity. The family’s philanthropic arm can serve as the core forum for all family members, helping them regularly coalesce on common ground. It’s a model that was successfully applied by the Rockefellers and is now being replicated by the Gates Foundation.

“Philanthropy is a very effective vehicle for bringing the family together to discuss the intersection of wealth and values,” says Hernandez. “We do find that most families with significant wealth also have significant charitable intent. In our work, we have seen families benefit in unexpected ways from engaging multiple generations in philanthropy.”

Communication and charity may be essential, but there are other factors founders and entrepreneurs must consider for the longevity of their wealth. For example, the decision to bring in professionals to manage the firm.

In his most recent letters to shareholders, Warren Buffett mentioned that a team of professional managers will take over his role at Berkshire Hathaway while his eldest son, Howard, will retain a seat on the board and possibly serve as non-executive chairman. This structure ensures the business, now one of the largest in the world, is appropriately managed while the next generation of the Buffett family can help the organization retain its legendary founder’s core values.

“Howard is immersed in the culture, believes in, and can be expected to defend it,” says professor Lawrence A. Cunningham, author of the book Berkshire Beyond Buffett: The Enduring Value of Values. “There’s no better way to preserve a culture as generations come and go than to have children and grandchildren like him as the standard bearers.”

“Family businesses – any businesses – need to continuously adapt to stay relevant,” says Walsh. “The next business leaders may be family or non-family – whomever is qualified to run the day-to-day operations. Those executives have different roles to play than the owners of the business who define the long-term vision and goals for the business.”

Families structuring their estate may need to consider a framework that helps the next generation work together. The estate must be structured to balance fairness and longevity above all else. In most cases, this structure involves ownership from the family and management from external professionals.

There are some notable exceptions to this structure. Some families have managed to maintain both ownership and management through multiple generations. India’s Wadia Group, a 282-year-old conglomerate now worth over $10 billion, is still managed by the founder’s grandchildren and great-grandchildren. Japan’s Kongo Gomi had a more impressive run of 1,400 years before succumbing to debt in 2007. It was the world’s oldest family business.

However, sustaining success under family management over such a long period is extremely rare. Most families can expect to delegate managerial roles by the third or fourth generation in an effort to retain the value of their stake.

As Baby Boomer entrepreneurs gradually pass the baton to their sons and daughters, they must come to terms with the potential third generation curse. Efforts to reach out and talk to the next generation, structuring the estate around philanthropy, and hiring the right people based on merit may help them avoid the same fate as countless other family businesses.

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