The Generation Challenge

The old saying “from shirtsleeves to shirtsleeves in three generations” describes the inconvenient fact that family wealth is generally not being passed on beyond grandchildren. Reviewing Forbes’ Billionaires List indeed reveals that about two thirds of the wealthiest families are first generation, only 20% second, and a mere 10% third.

Why is it so difficult to stay wealthy for many generations?

Ignoring political revolutions, economic crisis and tax regimes, all of which are also very critical   the causes can often be attributed to one of the following:

  • Attitude
  • Impact of Large Numbers
  • Lacking Governance; disruptive Family Disputes
  • Poor Investment Decisions

Successful entrepreneurs create wealth. They are hungry and driven and expect to win.
The 1st Generation built a business capitalizing on an idea, most often worked hard and eventually was rewarded for the effort.
The 2nd Generation has witnessed the struggle of their parents and usually understands what it takes
to succeed.
The 3rd Generation, however, tends to be brought up wealthy and may have the idea that the family has always been successful and the family business will continue to succeed in the foreseeable future.  
Sustaining wealth requires generating wealth. How can you re-kindle appetite and perpetuate first generation success?

Impact of large numbers
Looking at a family tree reminds us that family members grow exponentially in number, whilst wealth grows arithmetically. Also, when accumulated wealth is split amongst siblings as part of every inheritance, a large pool of liquid wealth will become several smaller ones.  

Lacking governance; disruptive family disputes
Businesses fail because of lack of visionary leader-ship, poor decision making, and insufficient risk management. The same is true for managing family wealth.
The family business, often the source of wealth, follows a vision and is typically well led and managed by C-level executives. Clear responsibilities lead to accountability which in turn generate results. On the other hand, there is often little to no structure and guidance to help manage the family wealth. Who is the CEO, the CFO, and the Chief Risk Officer when it comes to managing the wealth outside the family business? Unclear responsibilities lead to lack of accountability.
Bickering Siblings, marital discord, and predatory advisors in the family ecosystem may throw a loosely defined process completely off track and put sustaining family wealth at risk.

Poor investment decisions
In particular, first generation entrepreneurs have their wealth significantly concentrated and are exposed to
the idiosyncratic risks of a single firm in a specific sec-
tor in one region. As liquid wealth starts to accumulate, it is often re-invested in a business, an industry, or a region that is familiar, which further cements the concentration risk.
Investment decisions are often made ad hoc on a bank/broker-portfolio basis ignoring how they affect the probability of meeting the investment goals or the overall risk exposure of the consolidated portfolio.
Deal flow is often not managed. Buy decisions are heavily influenced by conflicted sell-side brokers and personal relationships with a high degree of subjectivity that are prone to behavioral biases.

How can family wealth be sustained for many generations to come?

Critical Success Factors
Every family faces a unique set of challenges and it would be naive to believe that there is one solution that fits them all. As evidenced by successful families, however, there are mindsets, tools and best practices that have worked for many:

Vision: Intergenerational Equity
Every wealth owner must find the right trade-off between Lifetime- and Legacy-Spending (Owner vs. Stewart). Whilst the Owner feels entitled to consume all assets, a Steward has the ambition to preserve family wealth for future generations. This concept of Intergenerational Equity in an economical context is what educational endowments started to institutionalize since the late 1980s. The objective is to balance current with future spending needs so that there is a high chance that the real value of the capital is preserved in perpetuity.

Attitude: Strive for perpetual wealth generation
Every generation needs to be reminded that it is the “First Generation”, irrespective of its position in the family tree. It is important to recognize that every generation has the power to build a business around an idea and create a stepping stone for a new legacy. Generating wealth in perpetuity offers the most promising opportunity to overcome the impact of large numbers.

Structure: Institutionalized Family Governance
A shared vision, respected values, and specific goals are crucial for a business to succeed but also essential for a family to sustain its wealth. What does the family stand for? Is it an objective to dominate an industry or be associated with specific charitable contributions?
Qualitative aspects are often underrepresented but tend to be more important than quantitative. The mission should enable all family members to pursue happiness. If the next generation does not identify with the family vision and mission, they have no incentive to engage and the dynasty risks extinction.
Depending on the size of the family, a varying number of committees will need to be in place. As new members are born, others pass on and marital statuses change, governing rules need to be in place to constantly help with the division and assignment of family responsibilities. A growing pool of willing members with wide ranging skills and experiences is the source of talents and maturing members are given tasks and duties as soon as they can handle information responsibly. Guidelines to ensure a meritocratic culture and checks to guard against nepotism are an integral part. Frequent family meetings help to engage and educate the next generation.

Process: Professional Investment Platform
Capital preservation is not necessarily a “core competency” of every family. As in every other trade, skill, professionalism and focus make a big difference. Hence, dedicated professional management is highly recommended.