The following article relates to the dissolved German company FlowTex, and not to the US entity which operates under the name Flow-Tex.

In the 1980s Manfred Schmider and Klaus Kleiser started a business called FlowTex. They had the idea to build and operate machines for horizontal drilling. The machines allowed the installation of cables and pipes without digging up streets at lower cost, without traffic jams, dust and noise. Given the beauty of their business idea, the two founders had big plans with their enterprise: A sell-and-lease-back should provide the liquidity that was needed for the rapid growth plans. By 2000 they had sold (and leased-back) more than 3.000 machines at around 1,5 million DM a piece (equivalent to 750.000 EUR). But what started as legal business with a viable business model had turned into fraud: In reality FlowTex had only produced 181 machines that were sold multiple times. The certificates of the machines and the identification plates had been manipulated. Sometimes the very same machine was shown at different fake construction sites to potential investors during the same inspection – moving them from one location to another during the lunch break of the visit. At the end, Schmider and Kleiser were sentenced to prison for 11 and a half and 9 and a half years – they had caused a total damage of more than 2 billion EUR. Their “creative” way to finance the business and to raise capital proofed to be the entry point to a slippery slope that finally ended in the construction of a fraudulent Ponzi scheme.

Entrepreneurs usually start with great ideas and lots of energy. They need to focus on the development of their product or service, on their customers and on the market in general. This is the right focus! But in doing so, they shouldn’t forget to also watch out for ethical pit-falls inside their companies. And these pit-falls are typically connected to the internal development of the business: the basic challenges of start-up companies such as financing, recruiting and sourcing all lend themselves to unethical or illegal behavior such as corruption and fraud. In order to avoid such ethical issues, entrepreneurs – and especially The Good Entrepreneurs – should start to think about principles of corporate governance early on, e.g. by applying Derek Abell’s “7 C’s of good corporate governance”:

1. Codes of conduct:
   You need to establish clear rules of conduct, both for your employees, but also for external partners. While you will usually have some level of control over your internal resources, it will often be more difficult to ensure acceptable conduct of your suppliers (especially as you will usually be only a small but high-maintenance customer to most of your suppliers at the beginning). Start-ups should therefore select their business partners particularly careful – and also include aspects such as past conduct and reputation into the supplier selection. This will make you significantly less vulnerable to ethical issues.

1. Communication:
   Once you have defined the principles of conduct you need to ensure that everybody within your business systems knows about these principles. This will require multiple channels of communication. It will not be enough to send a memo once. You should also discuss principles of corporate conduct within your enterprise and with your business partners on a recurring basis. Use small but non-controversial situations to describe and differentiate acceptable and inacceptable behavior. And make sure that new employees and new business partners that join while you grow, know about your code of conduct.

1. Controls:
   Particularly as a start-up you need to avoid bureaucracy. You might want to give your team as much freedom to operate as possible. As an entrepreneur you might want to have intrapreneurs around; people who think and act as you, people who hate regulations, processes, rules and regulation. And you are right in doing so. But for the most relevant aspects of your business you need to establish a set of controls to monitor adherence to your code of conduct. And this should be done early on, because control systems need to detect inacceptable behavior early: A tax-investigation did find early signs of corporate fraud at FlowTex in 1996, i.e. four years before the end of the company! But the tax collector didn’t believe his own judgment: By then FlowTex was already so big, so well connected within the community, so much within the focus of public attention, that he thought that his own findings were just impossible.

1. Compensation and Incentives:
   The main focus of most start-ups are top-line growth and cash flows rather than profitability. Accordingly they sometimes neglect long-term dimensions of their businesses. Quite often they connect target agreements, promotions and variable payment to cash flow and sales growth. But this can not only lead to the acquisition of unprofitable customers, but also foster greed; greed that can easily lead to fraud or to the slippery slope of “massaged” forecasts, fabricated financial planning etc. It was some type of this behavior that led to the FlowTex disaster. You need to set the priorities of your people (and business partners) right – and link compensation and incentives to the adherence to your code of conduct.

1. Censure:
   Start-ups are small and don’t have a long history. Therefore every single incident becomes highly visible and extremely important. You need to set clear signs from the very beginning, even if this means to fire your top-sales person. If you start to compromise, it will be very difficult to ever come back to a clear policy later. Drawing conclusions from violations is important but not enough: All involved parties need to be aware about the fact that violations will yield consequences; you need to talk about the actions you take in case of violations.

1. Culture:
   The most effective way to minimize the need for “control” mechanisms is to establish a corporate culture that takes ethical aspects of a business seriously. To foster an ethical culture you need to involve the organization. It is not enough to declare a code of conduct ex cathedra. Make sure that your business “breathes” ethical considerations, that your people can discuss ethical issues and that they can raise topics that cause ethical concerns for themselves. You can even think about establishing principles for whistle-blowing to signal that the perspective of your team and every single individual within your business is relevant to you.

1. Personal leadership Conduct and Conviction:
   And last but not least you need to lead by example! Particularly in small organizations, the leader’s behavior sends strong signals to everybody inside and outside the business. If you cut corners every once in a while, your employees and business partners will follow! The FlowTex example is a sad proof: two founders initiated the fraud, but at the end there were legal investigations of about 110 people within and outside the company. In a giant downward spiral, the entire system turned fraudulent, leading to the biggest corporate scandal in Germany’s history after WWII.