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Fraud: Startups at increased risk

By Chris McCulloch, CFE
SVP, Corporate Security Officer
Enterprise Bank & Trust

Becoming a victim of fraud is probably not at the top of a startup executive’s worry list. However, businesses of all sizes are the victims of fraudulent behavior every day, and, interestingly, smaller businesses are at high risk.

Fraud comes in a variety of forms and from both external and internal sources.

Regardless of the type or source, the impact can be devastating – especially for a startup. March is Fraud Prevention Month so this is a great time to consider how fraud could potentially impact your business, and consider upgrading your fraud prevention procedures.

Devastating Impact

The impact of fraud on a business can be severe. The Association of Certified Fraud Examiner’s (AFCE) 2018 Report to the Nations reveals that the median loss to the organizations included in their study was $130,000 per fraud case. Even worse, in 22% of the fraud cases reviewed in the report, the costs to the organization exceeded $1 million. However, the total financial impact on these organizations was even greater. These costs do not include expenses related to hiring attorneys and other specialists typically called upon to address and repair fraudulent activity.

Besides the obvious financial loss, fraud can also harm businesses in more subtle ways. For example, the potential for damage to a company’s reputation can be significant. Fraud can result in a public relations nightmare, negatively impacting confidence in the business by employees, customers and shareholders. In addition to a tarnished brand image, decreased productivity and low employee morale can often be added to the list of negative effects of fraudulent practices.

Occupational Fraud

There are a number of types of fraud that impact businesses of all sizes. However, the most damaging fraud is often perpetrated by insiders. Most business fraud is committed by employees, and the vast majority are first-time offenders. Fraudulent schemes carried out by employees typically fall into one of three categories: asset misappropriation, corruption and financial statement fraud.

Asset misappropriation is by far the most prevalent form of occupational fraud. Theft of cash, skimming schemes and fraudulent disbursements such as check and payment tampering are common types of this form of fraud.

The second most frequent type of occupational fraud is corruption. Conflicts of interest such as purchasing schemes, or bribery in the form of invoice kickbacks and bid-rigging are examples.

More sophisticated and much less common, financial statement fraud typically involves the over- or understatement of net worth or net income. Although less frequent, this type of fraud can be particularly destructive. The ACFE 2018 Report to the Nations reveals that the median loss per case of financial statement fraud is over $800,000.

To make matters worse, the ACFE report also reveals that fraud victims are rarely able to completely recover their losses. The ACFE notes that in 53% of the fraud cases studied the organizations recovered nothing while 32% made a partial recovery. In only 15% of the cases did the victims recover all their losses.

Startups are at Particular Risk

While any business can be the target of fraud, startups and mall businesses are at increased risk. Not only are small companies more likely to be victims of fraud than larger organizations, but they tend to have disproportionately large losses. Of the organizations studied in the ACFE report, small businesses lost almost twice as much per fraud as other businesses. The 2018 study concluded that the median loss for
companies with less than 100 employees was $200,000 as compared to $104,000 for companies with more than 100 employees. This report and other studies have found that small businesses are at higher risk of fraud because of lack of – or weaknesses in – their internal controls.

Fraud Prevention Steps

Because fraud is among the most common and dangerous financial threats to a business, it’s important to take steps to avoid being a victim. Experts in fraud prevention recommend businesses take the following precautions.

  • Ensure that no one person in your business has control of all financial decisions – separate financial duties and responsibilities between employees.
  • Have more than one person signing checks and accessing your online banking account.
  • Conduct background checks on all new employees, especially those with
    financial responsibilities.
  • Company owners should receive bank statements directly from the bank.
  • Periodically review employee timesheets, invoices and accounts payable.
  • Employ inventory control policies to track supplies and inventory. Perform periodic inventories – particularly for high-value items.
  • Do not send financial information through text or email as these are usually not secure forms of communication.
  • Maintain current and accurate accounting records. Each quarter reconcile all balance sheet accounts and payroll records.
  • Have an auditor or other outsider review your books and reconciliations at least annually.
  • Carry adequate employee-theft insurance.
  • Consider a surveillance system to keep an eye on customers and employees.
  • Promote an environment of honesty and ask employees to be on the alert for fraud.

Fraud often goes undetected for months or even years, so it can be a serious challenge to the success and survival of a business. Fraud prevention month is a good time to review your anti-fraud procedures and make upgrades as necessary.

For more information, check out “Fraud Prevention: Best Practices to Protect Your Business.”

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