You may trust your family with your life, but do you trust them with your business?
For many business owners the answer, with little hesitation, would be “Yes, of course.” When asked how they could be sure, the response is typically “because they are_____ (family, my brother/sister, my son/daughter).” And this is where the problem lies – trusting a family member more than any other employee merely because he or she is family.
Generally, trust is earned by an individual over time as a result of his or her actions and beliefs. However, when it comes to family, trust is often given as a result of simple familial status. This practice can have far reaching ramifications when the family member is also an employee or co-owner of the family business.
We are frequently reminded that small, closely held businesses, which are often family-owned, are most likely to be the victims of fraudulent activity by an insider. This is because of the trust that is often instilled in the employees which gives them the opportunity to commit the fraud. I have performed many investigations in which an employee abused the trust instilled in him by his employer for his own financial gain; mostly embezzlements or waste/mismanagement of assets. However, some of my investigations have been of fraud committed by a family member who was an employee and/or a co-owner of the business. When fraud is committed by a family member, in addition to financial loss, the impact on all family members, regardless of whether they are involved in the business or not, is also significant and can potentially change the family dynamics forever.
Several years ago, I had a discussion with John, who as owner of a small, family business, was concerned with profitability even though operations were consistently busy. I posed several questions to him regarding the company’s internal controls, specifically as they related to cash receipts. He informed me that the company received on average $4 - 5 thousand in cash and checks from customers. Each day John, after counting the checks and cash, would fill out the bank deposit slip which was then deposited in the bank by Frank, John’s brother and co-owner of the company. When I asked John if he ever compared the actual deposit receipts provided by the bank to the total on the deposit slips he had prepared, John replied, “No, I trust my brother.” Once I heard this, I knew the cause of the company’s profitability problem. Now it just had to be proven.
I asked John to compare the total on the deposit slips he prepared to the receipts from the bank for one week. After three days he called me and asked if he needed to continue the test for a whole week since his brother had not deposited approximately $2 thousand of the cash he was given each day. After confronting his brother, who denied any wrongdoing, they parted ways and the family has not been the same since, but the company is far more profitable.
Not all family businesses end up this way; many are successful and are passed down from generation to generation. However, a business is a business, and it should be treated that way regardless of the relationships between the owners and employees. All businesses should have controls in place to prevent fraud from occurring in the first place. If putting these types of controls into place causes “hard feelings” or feelings of mistrust between family members, then all involved should be educated on smart business practices, policies and procedures, and how they are designed to protect the business, which is often the major asset within the family. If these suggestions are still met with resistance, serious consideration should be given to whether or not the parties should go into, or continue doing, business with one another.
While implementing internal controls can be costly for a small business, some controls like the one I advised John to use did not cost the business anything, nor did it take a lot of time to execute. However, it did save the business a significant amount of money (approximately $400,000 to $500,000) annually.
Another cost effective control is to always be looking for potential “red flags.” One such red flag is a person who is either living beyond his means or has financial difficulties. Going back to John and Frank, John always wondered how his brother supported his lifestyle. Frank had two vacation homes, several expensive cars, and children in college. John and Frank both earned approximately the same amount of money, yet John could not afford these luxuries.
Besides living beyond one's means, employees engaged in fraudulent activities often share these characteristics: 1
- They are male between the ages of 31 and 45;
- They have a college or post graduate degree;
- They have control issues and are unwilling to share duties;
- They are extremely trusted and perform multiple roles within the business (i.e., the “trusted bookkeeper”);
- They do not take long vacations, or do not take their full year’s allotment of vacation time for many years in a row;
- They have a problem with drugs, alcohol or gambling; and
- They are guarded and unwilling to allow their work papers to be reviewed.
These characteristics are not meant to be used as a bright line test to determine if an employee is involved in fraudulent activities, but based on studies, are merely signals that a problem may or could eventually exist and should be investigated.
Having internal controls in place is just as important in a family-run business as it is in any other business. In fact, it may be even more important. In addition to saving the business money, it could save your family relationships as well.
1 Association of Certified Fraud Examiners 2010 Report to the nation on Occupational Fraud and Abuse.