Jeff: Welcome to Deal Talk brought to you by Morgan & Westfield, I'm Jeff Allen. If you're looking to sell your company now or at some point in the future it's our mission to provide information and advice from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
Fraud is a difficult subject to discuss without stirring negative emotions to some degree and creating a sense of heightened urgency and concern. I know. Fraud in its many forms result in the loss of millions of dollars for business owners each year. How do you know if you and your business have been victims? Well, it's not always easy to tell. But today we're joined by someone who knows what to look for and he'll share some of his insights. His name is Bob Bates. He's Chief Financial Officer at HP Accounting Services and also CFO of two other companies, PIQ and Velocity Data in the Bay Area. Bob Bates, welcome to Deal Talk sir, it's good to have you.
Bob: Thanks Jeff.
Jeff: You wear a lot of hats, Bob, and you've been around in sitting as controller and CFO of a number of different companies. You have a long history of being there on the front lines where the money comes in, where the money goes out, and kind of watching every penny for these companies that you've been with. How bad is fraud as far as far as a concern in American business today? Is this something that's getting worse? Are we seeing improvements in it? Just from your perspective?
Bob: Sure. Let me just preface it to say that I do deal with a lot of acquisitions and I’m a CTA and I'm also certified in forensic accounting and valuations. And so I've kind of come at this from different perspectives. But as far as like for example the American Association of Fraud Examiners, they do a lot of studies on how much fraud is out there and it's really a lot more common than people would think and until they’re actually a victim of it they just think of this as a bad word and it's something that isn't affecting them, and they feel this false sense of security. And so it's really important to be aware of what potential types of fraud that there are and warning signs, and have a plan in place really just like for anything else. Like if there was a bad weather and/or something that affects your location you have a plan in place contingency to get things back on the right track.
Jeff: How can fraud impact a business in terms of ... Are we talking about can it have top line impacts? How does it impact earnings and valuation? What have you found?
Bob: Really because we're kind of in the context of acquisitions. But even for somebody that's not looking to sell their business right now they need to be aware of potential fraud. And so I think that there's two categories of fraud that we should look at it in this context. One is obviously a seller can defraud a potentially buyer. There can be a potential fraud in that regard. But let's not go into that too much, let's think of the fraud that the company or the owners are a victim of. And you can break that down really into kind of where did that come from? Did that come from internally from an employee or did it come from some kind of an external perpetrator? And so there's so many fraud schemes out there that it's really important to be aware of what's come of them are and, like I said, to look for the warning signs. So I worked on two major – major for me, they’re six figures - and major for the company, two major fraud cases in the last five or so years. And so the first one was a situation where there was a bookkeeper who was basically paying some of her bills through the company. And that situation, they weren't even looking to sell, but you can imagine that that obviously skewed the earnings. And so the company was profitable enough that it wasn't as noticeable as it should have been. There was auditors in there, there were other consultants and finally I was the third set of eyes really to get in there and I was the one that discovered this. And so once you really add that again all of those expenses that weren't expenses of the business you all of a sudden have a company that was even more profitable. But on the same respects you have a bad connotation. When people looking at it, they don't want it to get out in the press. Or if they're selling it, it conveys a message to a potential buyer that the controls aren't strong. And so it's really important to consider the effects on valuation.
One is obviously a seller can defraud a potentially buyer
Jeff: Boy Bates, he is the Chief Financial Officer at HP Accounting Services, if you're just listening over someone's shoulder right now. And we're talking about fraud today and just how big of a problem it is in business today, and how it can impact your earnings valuation, and really just cause a whole lot of problems for you, particularly if you have an exit strategy in place and designs to sell your company at some point down the line. Bob, getting kind of back on track I recently learned of a small company here in my neighborhood that lost $70,000 because of fraud. Depending on how big your business is, $70,000 can almost be the kind of hit that you could take that could close up your company, I mean if it's a small mom and pop kind of operation. You mentioned an example where it was someone kind of paying their bills using company funds. I would imagine that that had got to be among one of the most common examples or illustrations of fraud that is out there today. We've heard of people going shopping and spending money on lavish gifts for friends and stuff. But I'm just kind of wondering, is internal fraud a bigger issue today than being defrauded by say a business alliance that you have or a business partner, or some kind of a deal maker that you do business with outside the company?
Bob: I think that the frauds perpetrated from the inside are historically more common. You have things, kind of warning sign. You look at a bookkeeper in a smaller company and you have to ask whether they have the means, the opportunity, and the motive to perpetrate a fraud. But it's interesting, and I think it's important that people be aware of the external frauds because the second fraud case that I was involved with, it was just this year and it's people that I work with. Basically what happened is that there's these crime rings out there and one of them is for example if you're the CEO and I'm the CFO of a company, and you normally tell me what wires to send out. What these groups do is they'll spoof your email and they'll send me an email that says, "Please send us $25,000 today" and it gives the wire instructions. That's an electronic cybercrime. And I think it's because of the cyber nature of it that's why it’s newer in the last 10 years or so. And the particular instance that I was involved with and got involved with the investigation and worked with the FBI on and so forth was a purchase order fraud. And so what this group did was they pretended that they were the government. They sent emails with military extensions and we even talked to them. Some of the people that I worked with talked to them on the phone before the orders were placed. So they placed hundreds of thousands of dollars of orders for computers and they actually used military addresses to have them shipped to. So everything ... but that point sounds okay, right? So you're making a profit and doing a bunch of business, this is ... maybe even a customer that you've dealt with before. Well, lo and behold a month later there's no payments coming in and things start to unravel and then all of a sudden the FBI showed up. What they did is that these people would work with FedEx to have the packages picked up from FedEx or have ... where they had some contact in the military or they knew enough about the military to redirect things from a regular loading dock at one base in Seattle and ship it across the country to a barbershop in Virginia, on a military base still. And so it's really amazing how brazen some of of these people are. It's really difficult to try to set-up controls for all of these things. But if you keep a good eye on all of your vendor lists and your customer lists, and look for any warning signs. If it's a government order people probably aren't going to be in a rush because the government isn't necessarily in a rush to do things, they go about things with procedures and so it's really just a matter of kind of having a sense of what's going on in your business.
Jeff: The idea of fraud, it's very clandestine. Some of these plans are so well thought out, they're so detailed. And every consideration is made it seems that there's kind a backup plan if things don't go well for the people who are committing the fraud. And the fact that it involved the military addresses and things like that. Anyone in their right mind just kind of doing their everyday job wouldn't question people like that, they wouldn't think of it. It doesn't sound like something that would be of a big concern. You have on your website hpaccounting.com, Bob, you've got some ideas for some things that one can do, a business owner can do to kind of ward off the possibility of fraud, or certainly reduce the risk a little bit. We'll just take a few of these items and we'll go kind one by one on these. And the first one I think you have here is probably the most important and that is communicate to employees. Everybody thinks that they've got a great team set up, but everybody's busy doing their jobs and they're not always looking for things that aren't quite right or on the look-out for those types of things. Just kind of talk a little bit about the importance of the employees in getting everybody on the same page there.
Bob: I think that really setting the tone through communication from management to employees is important so that employees are respected but at the same time they're made aware that there's controls there, whether the company is audited or whether there's the CEO or COO, somebody in a senior position is reviewing the work. They're reviewing things randomly, they're reviewing things thoroughly, and whether it's opening the mail before the accounting people open it, or it's looking at who are the check signers, comparing signatures on checks. There's so many things that can be done, and I think it's important for employees to take regular vacations so that if there's been some kind of a scheme set up that all of a sudden there’s an inconsistency and it will unravel. All those things are important.
I think that the frauds perpetrated from the inside are historically more common. You have things, kind of warning sign.
Jeff: Controlling the mail room, Bob.
Bob: Yeah, I think that's really the center of where a lot of things start. If you've got an employee that's set up fake vendors, they're going to try to go around the normal channels. And so you can only do that to a certain extent because, obviously, the true vendors are going to send their invoices, sometimes by email now. But the historical way is through mail room and so that's really one of the most important areas of the company from a control standpoint.
Jeff: This next one too, we're going to take a break in a minute, Bob, but I want to get to one more here. Review bank statements before your bookkeeper. Tell us a little about that.
Bob: Yeah, that's most of the company’s financial happenings really. So you don't want the opportunity, and obviously it seems far-fetched in some situations but you’ve got bookkeepers out there who will actually make alterations to the bank statements. So this is why auditors during an audit will request the bank statements directly from the bank. It's really the source of the information, where did it come from? Is it direct or did it go through multiple channels where it can be altered, and that's the risk.
I think that's really the center of where a lot of things start. If you've got an employee that's set up fake vendors, they're going to try to go around the normal channels.
Jeff: Very important right there, Bob, and we're going to kind of just leave it right here for the moment as we get ready to take a break. We're talking about fraud and we're talking about warning signs, we're talking about how you can try to eliminate some of the issues before they become a problem and then contribute to all kinds of issues including reduced earnings. And worst of all really reduced valuation of your company. Because if you've been working very hard at building success for your company, for your employees, and you've got a plan to leave your company at some point, sell it off, and then all of a sudden you get down to the end of the line, you find out that you've been ripped off and for whatever reason you haven't been paying attention, you could come to a point where everything you worked so hard for could be in the toilet. My name is Jeff Allen and we're going to be back with expert Bob Bates. He's chief financial officer of HP Accounting Services, also CFO of two other companies, PIQ and Velocity Data in the Bay Area and a lot of experience in this area. And we're going to continue our conversation when Deal Talk resumes in just a moment.
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Jeff: Welcome back to Deal Talk. I'm Jeff Allen with my guest Bob Bates. We're talking about fraud. We're talking about how you can work to prevent it, and what you should do once you've discovered it. And I think that's kind of a good place to jump off here for the second half of the program. Bob, it's not always easy we've heard for people to understand the severity of the situation that they may be involved in particularly if they're just getting this idea that things aren't quite right, that money is somehow walking out the door. I guess the question here is: if one suspects that his or her company is the victim of fraud, what should they do? Is there a call that they need to make to a professional in that area first before they do anything else?
Bob: Yeah, I think they want to try to gather as much information as they can without attracting attention. Because if you've got somebody who's perpetrating a fraud from within then you want to be able to contain them. And so you don't want them to run off. Because the first fraud case that I've mentioned there was this situation. What happened was the CEOs eventually contacted the police. They worked with us. We were acting as financial consultants, CPAs, advisors, and then there were lawyers involved. And so one of the first steps legally after it was confirmed that this person did perpetrate a fraud was to put a lien on their house. So in addition to going to insurance and doing all these other things they want to try to be made whole. And so you have to consult with people that have gone through this before. You also don't want to spend all of your time on it. One of the owners was actually really kind of hit hard by this. He felt kind of dumbfounded and he probably felt embarrassed, with all these people looking at his company and he didn't realize this was going on. And so you want to try to get some help.
Because if you've got somebody who's perpetrating a fraud from within then you want to be able to contain them. And so you don't want them to run off.
Jeff: There's obviously a due diligence process that is involved. Is that due diligence that one would do obviously using some professional assistance, probably maybe of a forensic accountant? And I know that Bob, you've got some experience in that area. The due diligence process, is it much different from the kind of due diligence that one would do when they are preparing to sell their company?
Bob: It becomes more detailed, but I think at the beginning when I first went into that situation I was really scanning through all the detailed transactions. But the problem with getting summary reporting and just your basic financial statements which is something that a buyer would ask from a seller is that they don't really tell the whole story. And so you really got to have an accountant in there to go through the general ledger. It's great to even have an audit done before you buy the business. On the other hand, when you're looking at a fraud examination you're starting from that point. But that's where you go down a different path because you bring in people that deal with fraud examinations, you use special software perhaps. The larger the fraud, you have to go through investigative techniques. You may be interviewing suspect or other employees, and those types of things a lot of times are best done by a professional. So they start out the same way but they definitely branch off into two different directions.
Jeff: Bob Bates, by the way, if you're just listening over someone's shoulder we talked about this at the front. He's got a lot of experience as the controller and CFO of several companies. He's currently CFO of three companies right now as it stands at least. That's what his LinkedIn profile says. He told me his website was in need of a little updating and so we know that he probably has a lot more experience in maybe what that shows. But he's talking from really the perspective of someone who's had a chance to really kind of be in once again on the front end of the checks and balances so to speak, the financial operations of the companies he's been contracted to help and those he's worked with. So he knows what to look for. He understands the warning signs, and he knows what business owners are up against. And really when it's your business you need to kind of step out a little bit. You talked about possibly embarrassment and all the other emotions that come with this discovery, Bob. And we find out yet thousands of victims every year, business owners, some of it more serious than others. Fraud really is something that has been around forever and will continue. It's just a matter of being a lot more diligent and understanding the comings and goings of the money in your business. I wanted to touch on just a few before we continue our conversation in detail on a few of the fraud checklist items that you have on your website, and we'll touch on just maybe two or three more. And it goes back to maintaining current and accurate accounting records and why that is so important. But if you could just kind of maybe repeat maybe some of the things you've talked about so far here and why it's so important to keep such accurate tight records, that would really be helpful.
Bob: It's important to keep the books current. That's a red flag to a buyer, to even a CEO. We've looked at people that I work with and I looked at hundreds of acquisition opportunities in the last decade. We've actually gotten fairly close on 25 of those and we've purchased a dozen. And I would say that having the books and records current or auditable is probably the most important thing that we've looked outside of is it the right business to buy and will it further our goals. And one of the reasons for us is that we deal in the public company environment a lot and so in that situation it's going to be audited anyway. It's easier to get it audited before you buy the business or simultaneous with even if you have to pay for it. It's just the cost of the transaction. Once you've got those audited statements you have a lot more confidence. If you're doing some type of adept purchase then the lender's going to require that anyway. And so it's probably up there at the top three things that is really part of the due diligence process.
And so you really got to have an accountant in there to go through the general ledger. It's great to even have an audit done before you buy the business.
Jeff: Another one, monitoring your approved vendor list is also one of these items that you have on your fraud checklist as well.
Bob: Yeah. So that's where in that first fraud case what happened there was that when I was scanning through all the detailed transactions I noticed that there were just too many checks cut to the bookkeeper and sometimes in a small company, it can be done out of convenience because perhaps there's not a credit card in that person's name and they used their own money and then they get reimbursed. But it really gotten out of control. And in some frauds people will go and set up fake companies. So they're issuing checks to Mick Cafe or something and there is no Mick Cafe. So they've created a company with that name. They've actually gone and set up a bank account and that's how they're taking the money. So the CEO or whoever's in charge is going to know that that's not a vendor that their company has ever dealt with or should be dealing with. And so that's the red flag.
Jeff: I think maybe a way that we can end this discussion today, Bob, on this particular segment is just kind of gaining an understanding of if you cannot get your arms around the fraud situation at your place of business, if you choose not to for whatever reason. Maybe you don't think it's a big deal. Maybe it's just a few thousand dollars from what you can see. But actually the problem may be much more grave than that. Tell me, if fraud is not uncovered and dealt with in a company and eliminated it can kill an M&A deal, can it?
Bob: Sure. It’s a red flag and reduces the confidence of the buyer. And it can kill the company even if it's not being sold. Obviously from a financial standpoint the company that I was dealing with that had this fraud with the government situation with the fake POs, now they've had to go to all of their vendors and ask for extended terms. Because they were already maxed out with their bank facilities. And so it really creates a huge mess.
It’s a red flag and reduces the confidence of the buyer. And it can kill the company even if it's not being sold.
Jeff: Bob Bates, you have some outstanding credentials. You have a tremendous depth of experience and some knowledge that I think would really be important to share with our listeners. If they've got questions and they would like to talk to you about their own particular situation and perhaps even talk to you about coming in as a consultant to help them eliminate some of the issues that they're having. And it doesn't have to be fraud related issues. You're a CPA, CVA, so you can provide some assistance where valuation is concerned, any questions like that, how can they reach you?
Bob: Sure. My website is hpaccounting.com and my phone number is 415-264-0984. And my email is email@example.com.
Jeff: Bob, we do appreciate once again you joining us today on Deal Talk and sharing your wisdom with our listeners and I hope that it gives them some things to think about when it comes to understanding just how important fraud is around the country in businesses today and that they just cannot be too careful with those numbers. Thank you again for joining us.
Bob: Thanks, Jeff. I enjoyed it.
Jeff: That's Mr. Bob Bates. He's Chief Financial Officer of HP Accounting Services, and also CFO of two other companies. He's based in the San Francisco Bay Area.
If you are a professional who normally consults with small business owners, a serial entrepreneur who owns multiple successful businesses, or a small business owner who has sold the business and you would like to share your experience with our listeners, we'd like to hear from you about joining us as a possible future guest here on Deal Talk. Simply give us a call at 888-693-7834. And by the way, that number I gave you is also the number to call for information on business sales and appraisals from our proud sponsor Morgan & Westfield. Deal Talk brought to you each and every occasion by Morgan & Westfield, the number again, 888-693-7834 if you're thinking about selling a business or buying one. You could also visit by the way morganandwestfield.com. For Deal Talk my name is Jeff Allen, looking forward to talking to you again soon. Thanks for listening.