Why Fraud Has Such an Impact on a Family Business

Credits: Manager, Sobel & Co., LLC

If we look at the standard definition of business, it is generally defined in one of two categories, either as a “Large Corporate Business” or a “Small Family-Owned Business.”. While big business is associated with Wall Street, corporate greed, and cut-throat dominance, family businesses are more commonly considered to represent the hard working middle class that is the backbone of America.  To emphasize this dichotomy, the media typically portrays family business and big business as a David vs. Goliath type situation.   

However, there are actually many commonalities between the two major business categories and one of the most important is Fraud.

Keep in mind that it is not only national and global retail organizations that are victims of fraud, although the biggest companies are the ones making headlines!  Those small and mid-sized family businesses that are not in the same category as retail giants like Target are still vulnerable - perhaps even more so - because of their size!

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Family Businesses are Vulnerable

Smaller companies usually have fewer staff and resources available to ensure the proper internal controls exist that can help prevent fraud.  

In addition to their size, family businesses are usually tightly knit organizations, proud of their trusting culture and the confidence they have in each other’s integrity. This positive attitude can reinforce the belief that they are not likely to fall victim to fraud. As a result, family businesses tend to ignore the importance of having systems in place that support segregation of duties and other measures that guard against fraudulent behavior.

Blind faith can be dangerous. Some family members and nonfamily staff may feel entitled to profit more than they are receiving; some may be in the position of having the opportunity to divert some of the company’s cash for their own use without immediate detection; and some may be in a stressful situation that can be alleviated by misappropriating funds for their own gain. Often the employee, whether a family member or not, intends to repay the funds, but ultimately finds that they cannot do so as the debt mounts and the fraud continues.

A family business may also be more sensitive to the influence of the tone from the top.  The current leadership generation often establishes or perpetuates the original founder’s value system, attitude and culture. In a family business, these intangibles are embraced more passionately than they might be in a closely-held corporation that is not family owned or managed. The expectations for family members must be specific and fair – and should include the use of the company credit card, business perks (automobile – or automobile expenses), and a wide range of travel and entertainment expenses. . If guidelines are not set early on, it is much harder to revoke them if and when these privileges are abused.

Other nonfamily employees (and perhaps family members who are not currently working in the business) can quickly resent a family member for pushing the limits on “entitlement” challenges. If the same rule is applied to all and is adhered to in an objective manner – from the top – there is likely to be less conflict and less emotion surrounding the decisions, avoiding abuse and perhaps even down right fraud.

The most common fraud in a small business is typically perpetrated by the trusted bookkeeper.  The bookkeeper usually maintains a close personal relationship with the owners and, due to the small size of the company, is given several roles and limited restrictions to all areas of the business.  If you mix in a lack of segregation of duties along with a bookkeeper’s opportunity, personal pressures, and rationalization, you have the recipe for high risk fraud.   

There are many types of schemes that can take root in family businesses. Ghost employees, credit card abuse, cash skimming, inventory fraud and fictitious vendors or suppliers are all self-explanatory avenues that are fairly easy to execute and can go unnoticed for quite a while. This is especially true for family businesses where every member is trusted, checks and balances are minimal and few questions are asked.  In fact, family members are often too embarrassed to ask each other tough questions, preferring to assume that all will be fine.

But without deep pockets and significant resources to draw on, a family business can be destroyed by fraud if it goes on for a long period of time. 

Proper oversight and procedures can make it much harder to perpetuate financial fraud. Since it is easier and much less costly to have the processes in place to avoid fraud than it is to investigate suspected fraud and to attempt to recover the economic loss, it is critical that policies are established and strictly enforced (with no exceptions!) to keep the company safe.

In the short term, common sense steps can help send a message that fraud will not be tolerated, that no one is exempt, and that controls are in place that will aid in early discovery.

  • Review supplier and vendor lists regularly
  • Avoid using signature stamps and require two signatures for check signing
  • Separate financial duties within the office whenever possible so that one person does not have complete responsibility for all financial transactions
  • Review payroll, watching for unauthorized employees
  • Have all bank statements mailed directly to the owners.  Make sure the owner opens the statements and reviews them on a monthly basis for unusual expenses and/or signatures on checks.

Nearly every business strives to be known for its warm, trusting, and supportive environment. That does not mean that good business practices should be ignored. Being realistic means recognizing that any business, even those with family members at the helm, can be vulnerable to fraud - and that the best approach is to work to proactively prevent fraud whenever possible. Inconsistency or a lax approach can signal that you are not serious – while implementing strong internal systems can send the message that you are serious about protecting the company.

This column will provide business advice and new  perspectives on business news, emerging trends and traditional topics impacting individuals, family businesses and professional service providers across the tri-state area.

The opinions expressed herein are the writer's alone, and do not reflect the opinions of TAPinto.net or anyone who works for TAPinto.net. TAPinto.net is not responsible for the accuracy of any of the information supplied by the writer.

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