Coming to wealth is hard. Adapting to wealth can be harder. So for a family that will be passing substantial assets to future generations, what are your chances of success?
We have all heard the saying ‘the first generation makes it, the third generation loses it’. Dr Jim Grubman, a leader within the UHNW Institute, a think-tank addressing issues of concern for family office and ultra high net worth families, recently presented to our Global Association of Independent Advisors meeting on why this longstanding ‘proof’ needs to be challenged.
It has long been claimed that 70% of wealth transfers fail by the second generation, and only 13% of family businesses survive through the third generation. I’ve certainly heard these ‘facts’ over time.
Jim decided to go back and look at the study that concluded these oft cited statistics. It was a study by John Ward in 1987 called ‘Keeping the family business healthy’. It turns out the study was wildly oversimplistic. Here are the shortcomings of the study:
- Ward analysed public records on a cohort of 200 family businesses in a single industry (manufacturing) in a single region (Illinois).
- The criterion of success was whether majority family ownership passed to the next generation.
- The 70% failure rate of wealth transfers is simply the inverse of a continuity rate of 30%. There is no other substantiated evidence.
From a methodological standpoint, the Ward study has significant limitations. Its most serious problem may be its underreporting of positive or orderly planned outcomes for family businesses, therefore presenting an overly negative pattern that fell prey to oversimplification.
‘Shirtsleeves to shirtsleeves in three generations’ can happen and has happened, but there is no guarantee it will happen to your family.
So what does happen to wealth across generations?
Jim cited a well-crafted study in 2011[i] which found essentially opposite results from Ward. Focusing on what happens to business families, not individual businesses, researchers found significant longevity and success across generations as families pursued multiple entrepreneurial ventures. As a result, except for its still-frequent repetition in popular and professional writings, the 70% failure rate story has been dispelled.
Through Jim’s own research, he has categoried the three generations of wealthy families as follows:
- Gen1 creates a successful business and produces wealth for the family
- Gen 2 has the task of creating a great family to hold the success and build around it governance structures for more branches to be involved over time. The focus of Gen2 may not be growing, but rather building infrastructure to hold the business and enhance family understanding of what wealth means.
- If Gen2 does well, Gen3 has the ability to grow the business and further professionalise governance structures.
With appropriate guidance, families can and do succeed across generations.
How families engage and discuss wealth has evolved over the years. Jim provided this graphic below to describe his three stages of how families deal with wealth.
Wealth 1.0 (pre-1985) focused primarily on investments likes stocks and bonds, with advisers acting as stockbrokers and focusing on protecting and increasing wealth, period. The assumption was that rational professional advice was all that was needed; psychology and family relations were irrelevant or to be circumvented.
Wealth 2.0 shined a light on the complexities of family wealth and introduced psychology to financial services at multiple levels. Innovative financial regulations were enacted, investment vehicles expanded, the financial planning profession was founded, and a long-term bull market spawned significant wealth for otherwise middle-class individuals.
However, Wealth 2.0 also became a drumbeat of fear-based, unnecessarily pessimistic messages that perpetuate stereotypes about wealth and the wealthy. Every invocation of “shirtsleeves to shirtsleeves” feeds the fears of wealth creators and their families that entitlement, passivity and self-centeredness will inevitably destroy what was so carefully built, without any real proof beyond saying it’s supposedly universal, culturally.
For Wealth 3.0, Jim has identified three questions to help illuminate what needs to be done for the next major transition.
Question 1 – What do we keep from our past that still serves us well?
Valuable lessons include involving the family beyond just the wealth creating generation as well as advocating for greater transparency and shared accountability for what was once private and opaque. Coming together to craft decision-making structures and procedures that will last generations—no matter the size of the wealth—remains valid. So is the utility of creating a shared sense of mission, purpose, values and philanthropy via family meetings in an ongoing dialogue.
Question 2 – What do we let go of that no longer serves us?
The inherent negativity and pessimistic bias of Wealth 2.0 should be stripped away in all its forms. The wealthy should stop being portrayed as helpless actors hoping to fend off a generational curse that will inevitably rob them of all they achieved. We should stop invoking shirtsleeves to shirtsleeves, an outdated proverb too absolute in its perspective and discouraging in its message.
Question 3 – What do we learn and implement that will serve us into the future?
Wealth 3.0 is notable for its focus on strengths, inclusion, collaboration and rigorous professional practice. Drawing from the burgeoning field of positive psychology, it emphasizes possibility, positivity and creativity using the strengths and resources individuals and families already have.
A Wealth 3.0 approach seeks to provide early, accurate, helpful advice that bolsters good choices and praises success along the way. Wealth 3.0 is driven by purpose rather than fear. Holding family meetings, teaching financial literacy and creating foundations for the family’s values and collaboration can all still be done. But they can be propelled by an innate desire for engagement, mutual trust, respect and shared values.
How to deal with what is fair
Jim notes Wealth 3.0 takes seriously social critiques of inequality. But a question many of our clients grapple with is how to be fair to their children and grandchildren. Being fair and equal are not the same thing – they are actually different concepts.
Fair is about treating people according to their needs. This does not always mean it will be equal. Equality means treating everybody the same.
Being fair is always the goal. Equal distribution may achieve that goal, but not always.
We have seen clients who want to be fair, but fearful if they are fair, someone will get hurt, and thus default to being equal as they unsure of what else to do.
If you feel this fear is driving your own legacy planning, we need to dig deeper to understand what is getting in the way of seeing something other than equality being fair. There is no silver bullet to this question, but you should feel comfortable to raise and explore this issue with your advisers.
If you would like to read more of Jim’s articles about helping families with the complexities of wealth, you can visit his website: https://jamesgrubman.com/
Author: Rick Walker, Lorica Partners
[i] See https://my.ffi.org/general/custom.asp?page=2011 Longevity Study.
Source for article: ULTRA-HIGH-NET-WORTH FAMILIES & FAMILY OFFICES by Dr. James Grubman, Dr. Dennis T. Jaffe & Kristin Keffeler, February 2022
