By Festus Adibe wrote:
By now we’ve probably heard the story of Brisk Capital Investments and how that went down. In light of that event and the many more similar events to come, I think this is a good time to talk about red flags you can look out for that suggest that the business you want to invest in might be a Ponzi/Pyramid scheme.
- We’ll start with the most obvious one which is: If you need to recruit more investors under you and they in turn need to recruit more investors under them so that you can make money. It’s a Pyramid scheme. I think this method is so obvious to most people now that I don’t think I need to go into detail on how it is bad and why it fails.
- The less obvious one is if they promise you high yield in a relatively short time. E.g. 50% ROI in one month or even something that sounds less incredulous like 50% return on investment in one year (note that some might split it into 5% or 6% a monthly returns). You might be dealing with a Ponzi scheme where they simply pay out old investors with new investors’ money.
Most businesses run at a loss or barely above margin. Those that manage to make good profit might make around 10% – 20% net profit a year. A 30% annual profit would be a spectacularly good year. So if anyone is promising you 50-60% (or more) annual return on your investment then they are probably doubling their money every year to be able to afford to pay that much out to investors. It is unlikely that there is any legit business that pays that good.
Unless the business is the new Facebook, Apple, Microsoft, Amazon, or Google with an entirely novel product that literally changes the world, it is unlikely to see those kinds of high profit. Such businesses are extremely rare. Heck even Apple and Microsoft et al at the onset couldn’t predict just how successful they would be. They have been crazy to promise investors a guaranteed 50% ROI every year.
You see, even if a new business shows up and is able to double their investors money in a year, it won’t be long before competitors catch on and all start the same business eventually shrinking the profits.
Typically as businesses grow, their profit margin shrinks while their revenue increases i.e. they have more money in cash but the percentage of their profit reduces. What this means is that you can start off making a pencil for $1 and selling it for $2 at a 100% profit but by the time you grow to selling 10,000 pencils, you won’t be able to sell them for $2 each so easily because there will be competition, there will be staff you need to pay to help you produce the pencils, there will be offices and storage to pay rent for etc. it’ll make more sense to sell wholesale and give large discounts instead of selling at retail and never emptying your stock. So you’ll see that by the time you pay staff and pay rent etc, your pencil is now costing $1.50 to make, then you give some discount to those who buy wholesale – selling it at $1.75 instead of $2. This means that in the end, your profit is now $0.25 on every pencil instead of $1 per pencil when you were still a smaller business. Your profit margin shrank from 100% to around 17% but your revenue grew from $1 to $2,500
The above rough illustration is important because when someone promises you a high return on investment in terms of percentages and knowing that his profit margin is likely to shrink as his business grows, how exactly is he going to pay you back your ‘guaranteed 60%’ at the end of the year if not by dipping his hands into new investors money? This is why you should be wary of companies like Chinmark, Barimike, Propvest etc as they just might be high yield investment programs.
- The third category which is arguably the most popular and have managed to survive for so long because they are technically legal are those companies that use multi-level marketing to sell products. You know them; they are the Longrich, GNLD, Oriflame, Forever Living Product, Herbalife etc of this world. They are essentially pyramid schemes that attach a product to themselves to make them “legal”.
So basically, you can make money buying and selling the product but the real money is made when you join the pyramid part of the system and start recruiting people under you. Have you ever wondered why their products are very high priced when compared to other similar products on the open market? Well, that’s because on top of their production and running costs, they need to pay all those people in the Pyramid.
Usually, with time, they suffer the fate of other pyramid schemes. The market becomes saturated, there are now more people at the bottom of the pyramid trying to sell than there are buyers. This is when the business slowly fizzles out – all the “I am my own boss” and “C.E.Os” gathered at the bottom can’t get a return on their investment and are stuck with product they can’t move.
It is at this point that the business moves on to the next country and starts the scheme all over again with fresh takers.
So how should you invest your money? First of all, before you put your money into anything, make sure that you understand what you are getting into. Do your research and pay attention to your emotional states. Don’t be distracted by images of success or celebrity endorsements or even success stories. Slow and steady increase in wealth is better than quick cash grabs.
As a general rule of thumb: Be wary if the details of what the company actually does is vague but how you will make profit and become a multi-millionaire is very clear to you.
“We are investing in forex.” Really? Show us your PNL (Profit and Loss) from your trades over the past year.
“We are investing in agric.” Really? Show us your farms.
“We are investing in real estate” Really? Show us your properties.
A good way to test if you’re getting carried away is after you have been pitched the ‘business’, try to explain the business to a friend.
Explain to your friend exactly how the business (not you) will make money and also, how things can go wrong causing them (not you) to lose money. Evaluate their risk and reward and see if it makes sense for a smart person to get into.
If you can’t do this convincingly, you just might have been pitched a Ponzi scheme.
Of course these are merely my opinions and are not financial advice. In the end you are the one ultimately responsible for what you put your money into.
Have a great day.