Robert Lenzer for Forbes
Harvard Business School Professor John Davis, an expert on family wealth, warned last night that many family wealth creators hang on to the family business long after their fortune continues to grow by 6% a year and lose the opportunity to sell at the peak point of the success curve.
David dramatized this finding by underscoring that only 103 of the 320 families on the Forbes 400 list in 1982-1987 were still there in 2011, meaning that almost 220 families had been replaced on the list of the wealthiest Americans inside of a quarter century.
“ Families hang in too long before either selling or finding another wealth creator,” Davis explained to an audience at the Harvard Club in New York City. The wealth creator, he stressed, could well be a portfolio manager who manages the assets of a family after the “intrapreneur” founder builds up the value and the entrepreneur adds to the value. A good example would be the Ford family that held onto its shares of the Ford Motor F -0.42% Co. too long, as the business deteriorated, while the Ford Foundation aptly sold its Ford Motor stock before the deterioration of the industry. ” Large wealth causes people to be more cautious and to hold back,” Davis says, which is part of he explanation for the cliche ” shirtsleeves to shirtsleeves in 3 generations.” This suggests that, by the third generation of a family business, the creative dynamism is gone.
Davis presented a chart that shows 1st generation wealth growing by a superior rate of 8.1% while in the 2nd generation the growth drops down to 5.9% before rising back to 6.7% in the 3rd generation. He also showed the dramatic rise and decline of the Vanderbilt family in the early 20th century when first a shipping empire and then a railroad giant made the Vanderbilts so wealthy they were able to build ten mansions in New York City and massive “ cottages” in Newport, Rhode Island, where they consumed a substantial part of their fortune on a grandiose lifestyle.
The proof of the pudding is that the Forbes 400 list in 1987 included only two of the family companies that had been on an original rating in 1917; they were General Electric GE -0.58% and Eastman Kodak, which after 1987 filed for bankruptcy. In other words it is enormously difficult to maintain wealth leadership and prominence after the first few generations of a business empire.
To avoid this disaster in later generations families must combine daring with prudence on the ay to diversification and identify a proper “wealth creator” either from within the family out outside of it to maintain a rate of growth in wealth creation that at least meets the average gain of 6% or more per annum.
An important dynamic in the reduction of the family’s rate of wealth aggregation in later generations centers on the number of family members growing at a much faster rate than the rate by which the assets are growing. This is a major danger in the later generations of a wealthy family where the different family branches are expanding with a number of children that dilutes each member’s share of the fortune. Quipped Davis: “If you quadruple the size of the family you need to quadruple the profits of the family business.” A rate of 6% growth in assets is not going to maintain the wealth position of family that quadruples in size.
For all these reasons and the proof that the wealthiest do not necessarily remain the wealthiest, Davis underscored that French economist Thomas Pikkety is wrong in insisting that concentration of wealth by the richest cohort will continue to grow at a superior rate and divide the very wealthy’s position in the top 1% of citizens as the disparity between the 1% and the rest of the population continues to grow.
The issue ultimately is “between a quick descent” of the wealth and “regeneration ” of the wealth. But, crucially, regeneration requires a family to find the proper outside “ wealth creator.” A related problem are the family members who have been living off the wealth created by an earlier generation, but who feel “apathy” in just passively using the wealth made by others for their own lifestyle.
The important lesson to be learned is just how hard it is to drive the family business or assets at a rate of 6% or better for generation after generation. The Rockefeller family, Davis suggested, has recognized the need for a wealth creating person every other generation to take bold steps rather than just play it safe. If you play it safe, you won’t get the return you need.”