Each year, we analyze a significant number of employee fraud cases involving small businesses. I’ve observed that employee frauds most frequently occur with moderately successful small businesses. In this context, the profile of a moderately successful business is one in which the owners enjoy an above-average living, but at the same time are not so successful to bring the need for a structured environment with layers of management.
A fraud can also occur at a struggling small business; but from a practical standpoint, this is less likely. A struggling small business inherently has fewer assets available for misappropriation. Thus, the incentive for fraud is not relatively high. Also, the owners of struggling businesses tend to watch the dollars closely, so a loss due to fraud would get noticed fairly quickly.
So, we have the moderately successful small business in the crosshairs of fraudsters. There is another common thread among the victim companies: in almost every case of employee fraud at the small business, there is significant deficiency in internal controls. It makes one wonder– do these companies intend to have weak controls? I’d venture to say no. Do the owners sit down and design a control structure that is highly flawed? Sometimes, but this is not often the case. So the problem is not due to ill intentions or failed designs. Instead, it boils down to priorities.
Small businesses are created by entrepreneurs. The profile of an entrepreneur is someone with great vision and great passion. Generally speaking, entrepreneurs are not driven by the quest for money. Instead, they have a passion for the product or service around which the business is formed. It is this passion that brings success. Therefore, money is simply a by-product of entrepreneurs pursuing their true passions. As a result, the financial side of the business is not a priority for the owner. The financial affairs are usually delegated to an employee with little or no oversight. And that’s how it all gets started. Managing the financial aspect of the business is not a priority, or sometimes even a concern, for the owner.
With the moderately successful small business, the owner/entrepreneur enjoys an above-average living, and at the same time pursues his or her passion. And with this, life is pretty good. Even if there is a fraud, as long as the owner continues to make his or her above-average living and continues to pursue his or her passion, the stolen funds are not even missed.
Within my firm, we see a disproportionate number of fraud with small medical and dental practices. This is a case-in-point of my premise. The owners of these firms are doctors and dentists. These individuals have a passion for providing patient care. They often have limited financial knowledge, and almost zero passion for finances. Their days are consumed with providing care. The last thing on their minds is how and when deposits are made. They simply trust someone else to take care of it. It is just not their priority. The lack of priority cause the owners to turn a blind eye to the financial side of the business, thereby leaving a gaping hole for a filching employee.
Fraud can stymie the growth of the moderately successful small business, thus prohibiting its ascension. But if the business avoids fraud and expands, it can successfully move to a safer playing field. With a greater level of success, the company will require layers of management to operate smoothly. And within these layers, a better segregation of duties and controls often exists, which helps prevent fraud. In the meantime, what is the small business to do? Find out in my recent post “Internal Controls and the Five Senses.”