Startup businesses are especially vulnerable to financial fraud and financial planning blunders.
A typical scenario is that a startup raises venture capital and immediately starts to work towards its business goals.
But here's what can happen along the way:
- Spending Too Quickly. Without good financial controls, a startup can quickly consume its funding faster than anticipated.
- Financial Fraud. Funded startups are easy targets for ill-intentioned employees. Whether it's submitting duplicitous expense reports or something as egregious as creating false invoices to be paid to a friend's business account, a startup can easily be victimized.
Investors hate more than anything to hear that entrepreneurs have consumed the funding that was supposed to last for a year in the first three months subsequent to the funding round. However, it happens all the time when adequate financial controls are not put in place.
Outright theft of the money can happen without anyone even knowing. In New York, a paralegal recently embezzled nearly $600,000 from a large company by falsifying invoices for an existing vendor. She created a new bank account, ostensibly for a law firm used by the big company, but she slightly modified the firm name from "Fish & Neave" to "Fish Neave," a business she claimed as her own. She submitted the fake invoices from Fish Neave and then volunteered to deliver the checks directly to the bogus law firm. She then deposited the checks into the Fish Neave account, her own account, which effectively gave her full control of the stolen money.
Could that happen in a small company? Of course. In fact, it's more likely to happen in a newly funded startup. The company may be rushing to hire its financial employees and fail to perform adequate background checks. Without appropriate financial controls in place, the company has unknowingly just let the fox in the hen house. Money starts to disappear but it's stolen in drips and drabs so that nobody notices.
Theft aside, money can disappear through improper spending controls even when all employees are honest. For example, if all employees can purchase items for business and charge them in without limit and without scrutiny, it's not uncommon for employees to overspend simply because they don't think about the bottomline or they don't shop around. An employee may choose a $300 per-night hotel room over a $75 per-night hotel room simply because there are no financial controls that limit the per-night stay amount.
The bottomline? Investors want to invest their money with businesses that they can trust. Part of gaining that trust involves putting in place the right financial controls to protect investor capital.
What sorts of financial controls are appropriate?
- Perform thorough background checks on all employees.
- Spot audit invoices (randomly select 10 per month) and contact vendors to validate the amounts.
- Don't let your financial employees hire their friends (i.e. accomplices)
- Don't let employees buy goods or services from friends or acquaintances without deep scrutiny from another objective party.
- Define spending limits for common expenditures.
- Define procurement procedures.
- Operate in accordance with a budget that defines spending in advance rather than just spending as the need arises.