Corporate Fraud In Startups: Why They Are Easy Targets

China’s largest property developer, Evergrande, was accused of falsifying its revenues by $78 billion and was marked the biggest financial fraud case in China’s history. Because of this, both the company and its owner, Xu Jiayin, were fined $580 million and $6.5 million, respectively, ultimately resulting in the company’s collapse and forced liquidation in 2024. This shows that corporate fraud is multifaceted; it can happen in businesses and leave unimaginable consequences.

In the rapidly evolving business landscape, scammers and fraudsters are improvising new exploitation techniques; however, understanding the types and nature of potential fraud is still the only way to prevent it. According to a study by Embroker, only 10% of startups survive. Surprising, right? Establishing a new company is like a gamble. Various pitfalls could result in all the hard work and generated revenue, resulting in losses.

That is why, along with scaling up your business, it is crucial to scale up your defenses as well.

Understanding Corporate Fraud

Corporate fraud is when a company or its employees do something illegal or unethical to deceive stakeholders or manipulate financials for personal or corporate gain. This can include inflating revenue, falsifying financials, insider trading, embezzlement, or bribery. According to the Association of Certified Fraud Examiners (ACFE) , corporate fraud can hurt businesses big time, financial loss, reputation damage, legal penalties, and shareholder distrust. High-profile cases like Enron and WorldCom show how corporate fraud can have far-reaching economic impact. Prevention strategies are to have strong internal controls, regular audits and compliance with regulatory standards.

• Types of Corporate Fraud

Although business fraud has many types, startups are vulnerable to certain types. Some common types are:

• Financial Fraud

This type of fraud involves misleading others about your company’s financial position or operations. Scammers and fraudsters make a pseudo picture of their company exhibiting fake success and growth to attract investors and secure funding. For this, they typically falsify balance sheets, inflate success, make fake revenues, or conceal liabilities.

• Investor Fraud

Startups usually rely on investments from third parties. Sometimes, a fraudster would trick you into making an investment in their company by making false claims and promises. In addition, this may also include making up a fake investment opportunity. Such scammers often sound smart as they use industry-specific language with the intention of gaining your trust so they can easily take your money as quickly as possible.

• Vendor or Partner Fraud

This type of corporate fraud happens when third-party vendors or partners rip off a company for financial gain. Startups are particularly vulnerable to this because they are so focused on growth and have limited oversight and resources.

• Employee Fraud

Employee fraud is when staff exploit their position within the company for personal gain. Startups are reliant on trust and don’t have robust internal controls, so they can be easy targets for this.

• Cyber Fraud

Cyber fraud is when someone attacks a startup’s digital systems to steal data or disrupt operations. Startups with limited cybersecurity are prime targets for cybercriminals. It can kill your startup. Getting strong cybersecurity, training your staff and updating your systems can help with preventing cyber corporate fraud.

Suggested Read: Significance of Corporate Investigations in Protecting Business Reputation

• Spotting the Warning Signs

Weak Internal Controls

Many startups are so busy scaling they forget to build internal controls. This is a breeding ground for fraud. Relying too much on one person to manage critical processes like payroll or procurement is a common mistake. For example, a startup might find out one employee has been creating fake vendor accounts to siphon funds, a problem that could’ve been avoided with proper segregation of duties.

Solution: Startups need to build internal checks and balances as they grow, even if it seems like extra overhead.

Cybersecurity Red Flags

Startups are on a tight budget, so they cut corners on cybersecurity. Unfortunately, that makes them a target for cybercriminals. Look out for unusual login activity, such as logins during odd hours or from unknown devices and unauthorized changes to sensitive data. For example, if customer complaints about data breaches suddenly increase, it might be a sign of ongoing cyber fraud.

Solution: Startups should invest in basic but reliable cybersecurity and train their teams to recognize phishing attempts.

Vendor and Customer Issues

Startups rely on third-party vendors or partners to scale fast, but these relationships can be risky if they are not managed properly. Vendors that can’t provide clear credentials or invoices that seem duplicated or inflated are red flags. For example, an IT vendor billing for services not provided and an employee advocating for their continued use could be collusion.

Solution: Thoroughly vet vendors and monitor procurement activities to protect startups from these schemes.

Financial Irregularities

Startups focused on growth often overlook small discrepancies in their financials—but these are the first signs of fraud. For example, an unexplained jump in revenue in the financials might be easy to ignore but could be manipulated to attract investors. Transactions without documentation or frequent “adjustments” in the accounts should raise flags.

Solution: Do routine audits even with limited resources.

Suggested Read: Behind Closed Doors: Can Corporate Fraud Undermine Your Business?

Why New Businesses Are Vulnerable

The reason why startups are at the top of corporate fraud cases is because of their very nature. These setups are more prone to scams and attacks for several reasons. Here’s what particularly makes them vulnerable:

Limited Resources

With limited resources for managing company operations, startups usually deal with everything on their own. This often results in overlooking many important things. Ensuring all security protocols requires robust management and both internal and external controls. However, due to the tight budget in the early phase, a startup may likely compromise in these areas, leaving them exposed to risks.

Reliance on Trust

Startup owners expand their business by establishing relationships with customers, suppliers, and other businesses. This reliance on trust in unknown or non verified entities makes them an easy target for potential fraud. 

Rapid Growth

New businesses are often in a hurry. They often don’t ensure comprehensive KYB and AML checks on their partners because of a shortage of time. This lack of examination or partner verification allows scammers to exploit their setup. Lack of due diligence opens the doors to fraudsters in the disguise of potential partners.

Insufficient Cybersecurity Knowledge

“An ounce of prevention is worth a pound of cure.”

                                                                 – Benjamin Franklin

Startup owners fall victim to scams because of their insufficient knowledge and resources. Unfortunately, in most cases, these individuals don’t even know how a scam works, which makes them vulnerable to different types of corporate fraud. Counterfeit websites, phishing emails, and cyberattacks can have devastating effects on startups, causing irreparable loss.

What Are Some Smart Strategies for Startups for Staying Safe

1. Corporate Screening: Analyzing the risks involved with business partners is the key to staying safe from the consequences. Protect your business by examining the company’s or any third party’s details. This involves scrutinizing its registration details, ownership structure, financial history, compliance with rules, and overall reputation. 
2. Due Diligence: Keep a watchful eye on customers and your potential business partners and vet them thoroughly before partnering with them. Implementing verification procedures such as Know Your Business (KYB) and Anti Money Laundering (AML) screening helps you make informed decisions before the fraud occurs.
3. Culture of Transparency: Fostering a culture of transparency within the business is an efficient approach to corporate fraud prevention. Encourage employees to report anomalies or suspicious activities and give them some channels where they can report freely by staying anonymous. This will promote open communications and accountability across all teams.
4. Strong Cybersecurity Measures: Keep your startup protected with strong passwords, two-factor and multi-factor authentication, and antimalware software. Stay updated on the new cybersecurity practices and tools and implement them timely.
5. Fraud Detection Tools: With the help of advanced technology, everything has nearly become flawless! Corporate verification solutions like The KYB provide real-time monitoring for a business. This can help detect fraud and reduce the chance of falling victim to scammers. 

Want to Know How The KYB Helps Mitigate Corporate Fraud?

Preventing corporate fraud entirely is challenging. Combining the best practices, such as corporate screening and due diligence, with the right tools and implementation you can reduce the risks. Businesses in their initial stages of growth face various challenges when dealing with fraud and scams. Limited resources and rapid scaling can often leave gaps in due diligence. The KYB provides robust verification solutions tailored to mitigate corporate fraud. No matter whether you are partnering up with a business entity or want to calculate the current risk of your current partner, we will provide you with the most updated status. We vigilantly monitor businesses by keeping an eye on their operations while falling high-risk entities.

Find out more about how you can protect your startup from fraud. Contact us to get a demo now!