Many times we’ve heard the anecdote that the first generation creates the business, the second generation develops it and the third reduces it to dust. Within this paradigm, it’s suggested that the third generation is responsible for the decay of the business and holds the reputational capital of the entrepreneurial family. But is this really the whole picture? Perhaps it’s more reasonable to suggest that the first two generations are co-responsible for the failure of the third generation. And that these failures could be avoided if the first and second generations better understood what made them successful and intervene in ensuring this intergenerational legacy continues.
In the beginning, there was innovation
Family businesses are often born out of a committed entrepreneur who is passionate about an idea that he or she has decided to make a reality. The successful execution of this idea is called a distinctive entrepreneurial orientation: the ability to ‘envision’ a project, a market, a business differently from others, at the right time, in the right territories, with the right people.
This entrepreneurial orientation then leads to the construction of a company that grows and develops rapidly, often with the participation of the second generation in its growth. As a result, it becomes a family business where the business becomes part of family life itself inviting itself into the home, sharing meals with members, and unconsciously becoming a member of the family itself. The love, energy, and passion that these first generations of entrepreneurs put into their business are some of the key factors for their future success.
The duplication phase
The company then enters a phase of leadership and structuring in which the second generation takes a prominent place. This structuring phase is then accompanied by a phase of very strong growth which is reinforced by the duplication effect of the original idea. Within this phase, the duplication takes effect across several territories, countries, or continents. Duplication occurs through the continuous improvement of an original idea where services, technical investments, and professionalisation of existing processes make the business more economically efficient. There is moreover a reinforced response to customer needs including proper CRM and digitalisation practices.
As a result, the turnover grows exponentially. This structuring phase becomes a concrete success for the family, reinforcing the reputation and brand image of the entrepreneurial family.
Resilience: an asset or a trap?
However, as time goes on the entrepreneurial family begins to lose the kind of early mentality which led to its success. Out of e fear of losing what they have gained, the focus falls to preservation and enhancing resilience to market shocks. Whilst there is a need for a certain level of vigilance, it can grow to a kind of paranoid anxiety which results in war tricks that become tricks that become inadequate to sustain or preserve the security of the company. It is not uncommon to find family businesses with two, three, or even four times more cash than they reasonably need to operate.
This overprotection of course creates resilience, but it also indicates the beginning of complacency. There soon arrives an imbalance between the company’s assets and private assets – and a general lack of investment in breakthrough innovations. This is where what we call the Disruptive Innovation Gap – or DIG for short – comes in.
The Disruptive Innovation Gap (DIG)
It is widely documented, that few family businesses make it to the third generation. Families that pass into this third generation fall into the category of ‘generative families’ as Dennis Jaffe calls them. These families are those that can succeed generation after generation by reinventing themselves.
Researchers have shown that family businesses have a paradoxical tendency to take fewer risks as success builds, as a result of a desire to defend and protect their patrimonial interests. This attitude allows them to get through economic crises more easily than others because they often have a cash flow that is much higher than their real needs. This is due to the weight of history and the rather low dividend distribution. However, this duplication phase accelerates exponentially the performance, growth, and wealth of the company, without developing new breakthrough ideas. This is where the disruptive innovation gap (DIG) comes on.
The balance of economic growth and entrepreneurial orientation
The DIG is the gap between the economic results and the entrepreneurial orientation (EO) of family organizations. This EO has been shown to be a common factor in all generative enterprises – that is, the capacity of each generation to develop its own entrepreneurial orientation, allowing the family business to meet the challenges of its time and the needs of markets.
Everyone knows that an organization must innovate regularly in order to maintain its market position and respond to consumer needs. But the shadow of the duplication phase is that the strong growth linked to the deployment on other territories hides the DIG. In other words, the strong growth that comes from replicating the original idea in different forms is not based on disruptive innovations. As a result, the entrepreneurial orientation of the family and the company’s capacity for disruptive innovation declines – or worse than that, is not passed on. As a result, when the next generation takes over, it encounters a period of crisis or loss of momentum without having the skills, energy, and entrepreneurial values of the first generation.
Expanding the inner circle
Many family businesses invest in innovative companies, but all too often they invest in projects that come to them rather than investing in projects that they need. It is important at this stage to strategically identify the company’s innovation needs, to create an investment thesis, and to be accompanied by the family office, a specialised consultant, or an investment bank to find the company’s future innovative projects. We are talking about the company’s inner circle.
However, what happens in the shareholders’ circle? There are three issues at play here: diversification of the family group, support for new generations of entrepreneurs, and the ability to attract the next generation. These three issues are all interdependent.
The new generation will be increasingly attracted by a project that makes sense to them and which, in our current context, could contribute in one way or another to structuring projects with a social and environmental impact. More and more families, particularly via their family offices, are setting up impact funds to invest in innovative companies in the seed phase. They sometimes take seats on the board in order to engage this next generation in their search for meaning. They also create family funds dedicated to accompanying family projects.
What they discover in the development of these investor skills is that diversification of the group can come either from within the company or from outside via other family shareholders. These external shareholders are oftentimes attracted by areas that can sometimes be extremely different from the initial business. This is where the ‘constellations’ of family businesses are based, where the historical business that may eventually disappear is replaced by a multitude of other projects that take over from the family project. Whilst this may seem threatening to a family, the ability to envision a project, a market, or a different business model at the right time, in the right territories, with the right people is crucial to longevity.