Entrepreneurs must avoid the many forms of fraud

Editor’s note: Michelle Stockman is an independent consultant with her company, Fort Smith-based Msaada Group. Stockman earned a bachelor’s degree from Loyola University-Chicago in communications and fine arts, and earned a master’s in entrepreneurship from Western Carolina University. Her thoughts on business success appear each week on The City Wire.

Search the word “fraud” on the Internet and you will find a mammoth list of types of fraud that include check fraud, insurance fraud, disability fraud, internet fraud, identity fraud, bank fraud, corporate fraud, mortgage fraud and much more.

It is a sad state of affairs that cheating has become so prolific in our world.

Business fraud lurks in the corner awaiting a single moment of weakness within the business to slither in and cause havoc. Regardless of a business size, the effects of fraud can ruin any business model. We know the famous fraud cases through Enron, Worldcom and Arthur Anderson. We’ve also seen fraud in Circuit City, Hollywood Video and Phar Mor (a discount pharmacy retailer).

From vendors to secretaries, taking a little here and a little there may seem harmless to the thief; however the results can be catastrophic for the business. For entrepreneurs who risk their life savings, any theft is more than enough. While fraud has been addressed multiple times here before, today the warning comes in the form of due diligence.

Investopedia notes due diligence is “an investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to a sale.”

Due diligence is the process of making sure that what you are about to purchase or get involved in really is the right step to take for the business. In making a purchase, due diligence uncovers all the expenses, benefits or side affects the purchase will have in the business. Meanwhile, due diligence is also a process to go through in hiring employees and more.

Due diligence is critically important for entrepreneurs seeking to purchase a business. Whether it’s your first business or another business acquisition to expand your existing business, purchasing a business is a process not an event. Besides investigating the business to see if it’s a good fit, entrepreneurs MUST investigate the business from head to toe.

There is a small business in town I have been actively involved with for the past two years. This business was started by a man (Mr. X) who opened the business with no intention of becoming a successful business man. However, he quickly fooled many into believing he was an inspired entrepreneur ready to build a business empire.

Mr. X is far too lazy for such aspirations. As his business practices left customers angry, his staff alienated and an innocent business suffocating; another honest business man became interested in purchasing said business. The honest business man glanced through sales, through the establishment and skin deep throughout the whole business. Everything looked great and the deal was sealed.

As Mr. X ran off into the sunset (surely working toward his next scam), a wake of problems arose. Shortly after the sale, the honest business man began his nightmare. Staffing problems, tax liens, equipment liens and more threatened every inch of the business’ survival. The honest business man’s dream sunk like the Titanic causing the business problems to ooze into his personal life with negative results.

God is good and the business was delivered a second chance; however not every business is given this chance after starting on a foundation of fraud. To prevent jumping into the quicksand of hidden problems in a business purchase consider the following in your own due diligence:
• Ask why the business is being sold. Beware of answers that just don’t seem logical (things other than retirement, other business ventures or drastic life changes that are causing the sell off).

• Have someone observe the business (if possible). Have a friend or family member act as a customer to see what their experience was from the point of contact through the product delivered.

• Ask for a specific list of what is included in the sale (property, business intellectual property, equipment, customer lists, etc.)

• Talk to existing customers to see why they are customers. Do the customers cherish the product or service or do they really purchase their experience with the current owner (i.e. will they continue to be customers when you become the owner).

• Obtain historic and pro forma financial records and review to see if sales are up, down or flat. Look for financial trends.

• Is the product or service this business is selling relevant in today’s market and what changes are going to be needed to continue being relevant in the market?

• Talk to staff and find out what the company culture is like or what the staff attitudes are about their jobs.

• Talk to the company’s vendors to obtain another view of how healthy the company is by seeing if they order regularly, pay their invoices on time and how the vendors are treated.

There are many more areas within a business to investigate before jumping in on a business purchase. Due diligence doesn’t just apply to purchasing a business, the same questions only modified will work just as well for a substantial purchase to use within the business.

Knowing what you are purchasing and what to anticipate within the business will prevent the occurrence of a Mr. X in your life.

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Stockman can be reached at [email protected]