Guest column from Mike Rosten and Emily Long published in the Las Vegas Business Press on March 12, 2012:
Starting your own business in a bad economy is not uncommon. Actually, if you look back through history, more people start new businesses during recessionary times than any other period. These tough times can motivate those who have lost their jobs or taken a pay cut to venture out, start a business, and become their own boss.
There are many great reasons why you should start your own business during tough economic times, including low interest rates, more affordable materials and equipment, and an abundance of qualified potential employees. Many people who decide to start their own business look at these positive factors yet tend not to think about some of the risks, like the hidden danger of an increased susceptibility to fraud. Startup businesses start small, and it is small businesses that are the most prone to fraud, not only from outside sources but internally as well. According to the Association of Certified Fraud Examiners’ (ACFE) 2010 Report to the Nations, “…the median losses suffered by the smallest organizations are greater than those suffered by larger organizations.”
When starting up your own business, be aware of the potential fraud schemes geared directly towards a startup.
- Grant Fraud – There is a growing number of online grant scams occurring to young entrepreneurs. Look out for claims of free startup money from the government. In general, the U.S. government does not offer grant opportunities for entrepreneurs starting up a new business. Also, look out for anyone who advertises government grant search services for a fee. Government grants are public and free to lookup through the website www.grants.gov.
- Intellectual Property Theft – In the early stages of creating your small business you need to protect your ideas and inventions from being stolen. Make sure to get a non-disclosure, non-competition agreement signed by everybody who knows about your ideas (e.g. employees, investors, manufacturers, etc.).
Then, once you get your new business up and running, be vigilant of external frauds that exploit small businesses.
- Credit Fraud – There are many ways a fraudster can obtain and use someone else’s credit. Request your credit report and set it up so that you receive email notifications of important changes. Enrolling in a credit monitoring plan gives you will 24-7 access to your credit report and score.
- Overpayment Scams – In this scheme, businesses are overpaid using stolen or counterfeit checks, money orders, or credit cards, and then asked to return the difference when the merchandise is shipped. Although they may seem legitimate, they are not, and so you lose the difference you’ve sent them in cash, as well as the merchandise you shipped. Never accept or deposit checks or money orders written out for more than the selling price, and never agree to wire back funds.
- Advance Fee Scam – An up-front payment is obtained for services to be rendered at a later date. This advance fee is accepted with no intention of providing the service. If you are asked to pay a fee for the promise of a loan or credit card, you can count on the fact that you are dealing with a scam artist.
These are just a few of the multitude of possible external frauds awaiting businesses. Unfortunately, frauds from outside con artists are not the only dangers that employers need to prepare for. The typical organization loses 5 percent of its annual revenue to employee fraud, according to the ACFE.
Dangers from Within:
Here are some of the most common frauds perpetrated by employees working at small businesses (less than 100 employees).
- Billing Schemes – An employee receives payment from their employer by submitting invoices for fictitious goods/services, inflated invoices or invoices for personal purchases.
- Check Tampering – An employee steals his employer’s funds by intercepting, forging or altering a check drawn on an employer’s bank account.
- Skimming – Cash is stolen from an organization before it is recorded on the books and records (e.g. an employee pockets the money and doesn’t record the sale).
- Expense Reimbursements – An employee makes a claim for reimbursement of fictitious or inflated business expenses.
- Non-Cash Misappropriations – An employee steals or misuses non-cash assets (e.g. an employee theft of inventory or borrowing equipment for personal use).
According to the ACFE, “…small organizations had a noted deficiency in internal controls that allowed fraud to occur. In nearly half of the cases at small companies, a lack of internal controls was cited as the factor that most contributed to the occurrence of the fraud.” The following is a list of things start-up employers can do to reduce their chances of becoming victims to occupational fraud.
- Segregate Duties – Make sure a single employee is not responsible for an entire accounting cycle (e.g. approve invoices, prepare checks, sign checks, post checks, and reconcile the bank account). If there isn’t enough staff to divide the responsibilities, make sure review procedures are in place, and go over accounting activities frequently yourself. You may also want to consider hiring an outside consulting accountant to review the books every quarter.
- Establish a Third-Party Hotline – Using a third-party hotline to report suspicious activity offers a level of anonymity, making employees more likely to blow the whistle on fraudulent activity. Make sure the hotline is available to customers and vendors alike.
- Know & Monitor Your Employees – Start by hiring the right employees by conducting background checks. No matter whom it is you hire, treat them like employees, not friends, family or confidants. Conduct surprise audits so that employees know you are watching; the perception of detection is a great deterrent.
- Educate Your Employees – Create a fraud policy and educate your employees during orientation, training, or other communications. Let employees know the cost of fraud and how it can impact everyone’s financial future. Make sure they are aware that you have zero tolerance for fraud.
- Tone at the Top – Business owners must create a workplace culture of honesty and values by setting an example.
Perpetrators of fraud often display certain behaviors or characteristics that might be indicators of a heightened risk for committing fraud. The most common behavioral red flags include employees who live beyond their means, have financial difficulties, control issues and an unwillingness to share duties, wheeler-dealer attitude, divorce/family problems, or irritability, suspicious or defensive personality.
Starting up your own business in a recession can be very attractive and beneficial, but make sure to educate yourself on what types of fraud risks may be lurking around the corner, and the best ways to spot and combat them. With the amount of money lost due to fraud by small businesses every year, and the resources used to address the aftermath, any effort given to deterring fraud in the first place would be a great investment.
If a start-up organization suspects that they have been a victim of fraud, a detailed investigation may be warranted. Forensic accountants and Certified Fraud Examiners (CFE’s) have specialized knowledge and skills to investigate the full-range of asset misappropriations through fraud and concealment.
Mike Rosten, CPA, CFE is a Principal with Piercy Bowler Taylor & Kern CPAs and Emily Long, CFE is a Forensic Analyst on his team. For more information on forensic accounting, visit www.pbtk.com.