“The Godfather” story revolved around the infamous Corleone family business: a dubious empire in which trust and loyalty were two integral components of its financial success. Yet despite this focus on familial concerns and reliance, betrayal still occurred, and in the novel, resulted in a tragic ending.
Unquestionably, your family business is different from the Corleones’, but perhaps you hold trust and loyalty in similar reverence. While these are admirable traits in a family structure, they are not a reliable failsafe to keep your business free of fraud.
In fact, family businesses are especially vulnerable to fraud. According to the Association of Certified Fraud Examiners, the largest businesses (those with more than 10,000 employees) experience fraud at a rate of 19.8 percent. Conversely, in companies with fewer than 100 employees, which are much more likely to be family-owned, 28.8 percent are fraud victims.
A closer look at family business fraud
What causes family members to betray those who should ostensibly be the closest to them? The same factors underlying the majority of fraud schemes in other businesses are also present in family-owned enterprises:
- Individuals who commit fraud often feel emotional or financial pressure. This can push them beyond normal ethical boundaries.
- They routinely rationalize their dishonest actions due to a belief that money or more authority was owed them.
- They often find themselves in positions where the opportunity to commit fraud exists, and they anticipate little risk of exposure.
What differs significantly in family businesses, however, is the role of trust. The level of trust and the quality of internal controls, have an inverse relationship, meaning as trust increases in a business, the quality of internal controls relaxes. This, in tandem with the aforementioned factors, creates a breeding ground for fraudulent activity in a business.
Trust can also muddy an otherwise clear-cut case of fraud when family members rely on exploiting their family ties to sidestep confrontation. For example, a family member may take umbrage at accusations. Or they may attempt to turn other family members to their side, relying on sibling allegiance, parental favoritism or a family desire for conflict avoidance. As a result, family members may be less inclined to treat the potential fraudster as an offending business associate, for fear of the breakdown of the family relationship.
5 ways to protect your business
When personal and professional interests collide, the best approach to maintaining success and prosperity — from both familial and financial perspectives — is to implement effective internal controls.
Here are five internal control suggestions to help you get started.
- Segregate financial duties. Bank statements should be opened by a family member other than the one preparing the bank reconciliations. Transactions and canceled checks should be reviewed by a third employee.
- Avoid signature stamps for checks. Family businesses should consider requiring two signatures on checks over a certain monetary amount.
- Review payroll, supplier and vendor lists. Payroll lists should be reviewed by someone other than the person preparing payroll. Reviewers should look for unauthorized employees and unapproved pay. The list of vendors should periodically be checked for fictitious or unrecognized names.
- Conduct frequent meetings about finances. Make sure all financial reporting is transparent. Even if an employee is not a “numbers person,” they should still make an effort to try to understand the business’ finances.
- Establish clear expectations among all employees. Be upfront with all employees on issues such as expectations, pay rates and other benefits.
When confronting fraud in a family business, it is vital to adhere to tried-and-true business principles, and not be drawn into discussions of family loyalties or dynamics. Remember that trust, no matter how important, is never an internal control. As Michael Corleone said, “It’s not personal … it’s strictly business.”
