Taking Ownership – AKA: Liberties Taken by Owners

Occupational Fraud – (Part 5 of 7)

By Mark Palmer, President e:countable, LLC

I don’t mean to step on toes here – but if you’re a business owner this can be a sensitive subject. All too often I’ve heard business owners make the comment: “I can’t be stealing from my business. I own it.” If you are 100% owner of the company this is partially true. Though the assets are yours, the IRS frowns on taking them out without properly recording them. But I digress.

When multiple owners of a business are involved, even one person thinking they have the freedom to do and take what they wish can spell disaster. The consequences of these attitudes and expectations will not only cripple your business it will ruin your relationships.

It all starts innocently enough. A couple of friends, family members, or business acquaintances think of a great business concept or are fed up “working for someone else,” and make the leap toward one of the most significant decisions of their lives: to start or buy a business. All the excitement, anticipation and work focused on making a start-up or buy-out business successful is quickly extinguished when owners don’t sufficiently define the responsibilities and understand the expectations of each other.

Without some kind of operating agreement and open communication structured into the business, one or more of the owners over time may begin to feel like he or she is doing more work or has become more valuable to the company than the others. The results are resentment and an owner with the attitude of “I deserve more.”

This shift in attitude opens the gates to a stampede of strategies in the mind of the owner. They can begin to feel slighted, and may devise ways to “get even because I deserve it”. All too often at this point I’ve seen an owner increase his or her salary, take cash out under false pretenses, or take other assets out of the company and/or use them for personal use.

Just like an employee, owners taking anything out of the company that they don’t want other owners to know about are more than likely committing a fraud. As an example, let’s say a company is owned by two people. One owner owns 60% while the other owns 40%. Should the 60% owner improperly take $1,000 from the company he is effectively stealing $400 from the 40% owner.

The most common preventative measure for this type of fraud is to develop a strong Operating Agreement BEFORE the company is created or purchased. This formal written agreement typically outlines how the entity is structured (Board of Directors, Officers, etc.); the rules for making Board and Officer-level decisions; buyout or company sale provisions; and problem resolution rules. Certainly, a qualified attorney and a good tax accountant should be involved in the planning of your startup or business purchase. They are critical to setting up your taxes and other strategies for operating your business, including a plan for selling the business someday. Operating Agreements are very important, but they’re only a part of the solution.

Structured, open communication is paramount to the health of small business owners and the businesses they own. By this I mean a schedule with regular meetings and an agenda must be followed to cover issues important to all owners. Sometimes, just as in marriages, having a third-party facilitate these monthly or quarterly meetings can be beneficial. Such a facilitator should have a strong business background, and a firm understanding of the nuances of multi-owner privately held companies.

There is no crystal ball and every possible scenario cannot be codified in an Operating Agreement. Just as in a marriage, expectations change and business owners face pressures and unexpected problems throughout their lives as business partners.

I once knew of two very close friends who worked in the same industry. Hard working and creative, they decided to start a business together and became very successful building a chain of locations. As time went by expectations began to change and animosity grew between them. In this case both felt slighted and began stealing from the company because “they deserved it.”

No attempt was made to communicate, until finally Owner A told Owner B one of them needed to buy the other out. With no buyout provision in the operating agreement, they haggled. Owner A wanted it so badly he agreed to pay B’s inflated asking price. Their relationship was seriously damaged. It wasn’t until after the purchase was closed that Owner A discovered where Owner B had stolen significant assets. This made the price paid even more inflated than the value of what was left in the company. As a result of the theft (on both parts) and the highly leveraged buyout, the company was crippled and closed shortly thereafter. The two people who were once close friends remain bitter towards each other.

Don’t let this happen in your business. Take your time to plan. Communicate and work through your differences. Personal relationships are exponentially, and eternally, more important than any business or money.

NEXT ISSUE: Payroll Prowlers. Is your bookkeeper taking more than their fair share of pay on payday? The sixth part of our series covers ways you can protect your business from this type of fraud. Want to know now? Call us at 757-962-1080.
Mark Palmer: Bio