Startups · Entrepreneurship

What to do when you find out management is misusing investor funds?

Anonymous

September 19th, 2016

My cousin is working at a an early stage company (Series A phase) where they have raised a ton of capital already from investors. He is in charge of finances. Even though the company is not profitable, and senior management does not have high salaries, my cousin finds very strange the lavish lifestyles of the cofounders and several entries that don‘t make much sense on the balance sheet. He is always shut down when he inquires about some of the expenses. What should he do given the circumstances?
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William Agush Founder and CEO at Shuttersong Incorporated

September 19th, 2016

If he's in charge of finances and the expenses are by any reasonable standard excessive or questionable he needs to confront the CEO and if he's shot down then he needs to reach out to a board member and alert them. The investors and board are expecting him to fulfill his fiduciary responsibility - if he doesn't do it and the board were to become aware of any questionable spending he'll be tarred along with them. Finance is not a rubber stamp.

Peter Weiss President at American Outlook, Inc.

September 19th, 2016

Lifestyles not matching income and not in and of themselves evidence of a problem.  People may have family money, had other successes, partners or parents making substantial contributions or even just choose to overuse their credit cards or home equity lines.  The later may raise questions about judgement and discretion but it is not an indication of malfeasance.

The rest of the situation gets tricky.  If your cousin is being asked to falsify, hide or obscure material information from the Board, other members of senior management or investors at the least he needs to document that he raised the issues with the managers whose decisions are causing him concern.  

Depending on the scale and details of the issue it may be appropriate to notify either more senior managers (although in this case I suspect the discomfort arises with the directions of the CEO or equivalent), the Board or company counsel.  Once he does this it is likely things are going to get uncomfortable and he should be prepared for unpleasant and tense relationships including possibly having to leave the company.  

If he is being ordered to do something he considers improper, illegal or inappropriate he should document the request, the reasons he objects and, if the order is not changed, resign with a carefully drafted letter laying out the situation.  He should always stick to the known, demonstrable facts and not speculate.  He should not communicate with the investors (except through their Board representatives, if any).  If he has prepared or signed any statements which he believes are materially wrong that have been given to banks or other lenders or regulators he should get advice about his obligations and personal exposure.  

This is a difficult situation and before taking any steps he should make sure his concerns are not the result of miscommunication, misunderstandings, incomplete information about compensation agreements which have been properly approved, etc.  



Vanessa CPA Startup CFO Consultant

September 19th, 2016

Great question!  I've worked with over 200+ Seed, Series A, and Series B startups as the CPA/CFO.  I've seen things that have made me hot mad, but weren't fraud.  

Twice, I've seen fraud.  The first time, the founder went AWOL and ran up ten of thousands of dollars at NYC restaurants, hotels, and Banana Republic.  He was not on a sales trip.  The board dismissed him the next week.  The second time, the prior "CFO" routed millions that should have gone towards tax payments to his own personal account.  There was a federal investigation and he's now in jail.

SO!  What do you do if you expect fraud?

First, determine whether or not management is truly misusing funds:
  • Analyze M&E: founders will eat, drink, and yes... go to strip clubs, Las Vegas, and ride in Ubers all day/night.  This is not however, "living large."  They have dedicated their life, soul, mind, body, every waking moment and sleeping dream to this startup.  Be gentle to them; these are small escapes in an incredibly stressful job.  As their accountant, though, you can call attention to the excessive.  Feather out the M&E into sub-accounts: In-office meals, Coffee, Dining Out, and Entertainment.  If its truly excessive, the board will see this and ask the CEO whats up.
  • Analyze founder reimbursements: every reimbursement should have a receipt.  Otherwise it's a Founder Distribution (or they've gotten away with a nontaxable event, a big no-no).
  • Analyze the Balance Sheet: those weird journal entries on the Balance Sheet... hard to say what they're for.  So make your CPA the bad guy/girl.  Contact her.  Ask her, "Hey!  Just want to make sure this is OK for tax prep purposes!?"  You'll get your answer!
Second, if you truly believe there's misuse of funds... take it up the ladder.  Over email and in writing.
  • Notify your Controller: what are the reactions?  If you're brushed off...
  • Notify your CFO: can they properly explain?  If they can't answer...
  • Ask the CEO: gently ask, "What do I do with these transactions?"
  • Take it to Board: Trust your gut... but gird your loins.  If you're wrong, you will be fired.
Its a tough spot to be in... and I wish you the best. If you're ready to jump ship, check AngelList for new positions.


Irwin Stein Very experienced (40 years) corporate,securities and real estate attorney.

September 19th, 2016

He should start sending out resumes and hire a lawyer.  Any advice for him to go the  board, outside counsel or anyone else without seeking his own counsel is plain wrong.  Do you know what a"fall guy" is?   He thinks that the co-founders are stealing investors' money and if he is correct then its theft. He should want no part in it.  He should put nothing in writing to anyone except his lawyer and under his lawyer's direction.  He should act very quickly. Letting something like this go on never comes to a good end.

Syed Hosain Founder, SVP Engineering and CTO at Aeris Communications, Inc.

September 19th, 2016

In his shoes, I would leave as quickly as practical and possible.

Assuming he is right in his observations, and he is obviously very ethical himself, your cousin should try to not be associated with the entity anymore. Indeed, if the founders are not spending invested funds wisely, then the long-term prospects are compromised.

Now, whether he tries to whistle-blow to the investors is a tough choice he could also make - depending strongly on how bad the problems are. He should be darn sure of the allegations though before whistle-blowing.

William Agush Founder and CEO at Shuttersong Incorporated

September 19th, 2016

Peter, I took the "several entries in the balance sheet that didn't make sense" to mean the lavish spending was using company resources. 

Peter Weiss President at American Outlook, Inc.

September 19th, 2016

Your reading is the reasonable interpretation but since the question wasnt explicit I thought Id point out the possibility of other explanations. After years of CFO for dozens of start-ups Ive learned to be aware while trying to not jump to conclusions. That said, the odds are good that something is not right in the situation. P Peter H. Weiss President, American Outlook, Inc. Providing Financial Consulting and CFO Services P.O. Box 1682 Mercer Island, WA 98040 206-890-4792 Fax 206-493-2800 pweiss78@alumni.princeton.edu

Rod Abbamonte Co Founder at STARTREK / @startupHunter / @startupWay / @CoFounderFound / @GOcapital / @startupClub / @lastminute

September 20th, 2016

Look for another job.

Martin Omansky Independent Venture Capital & Private Equity Professional

September 20th, 2016

Two items: (1) notify the investors, who will in estivate and might pursue a civil case; and (2) call the Attorney General of the State. Make sure of the facts first, and record them. Also, get the advice of a securities lawyer. Misappropriation of funds and breach of fiduciary trust are serious violations. Sent from my iPhone

Kelly Lefkowitz CEO at Strat/Assist, Conditioning Companies for Capital & Growth

September 28th, 2016

The fact that your cousin was "shot down" is a red flag for me.  If would recommend your cousin resign immediately. Their treatment of a conscientious employee raising a legitimate issue is indicative of bad management.  The resignation should be sent to each Board Member and it should detail the questionable expenses that have not been adequately explained and it should detail how they responded and how he was treated when he raised the issue.