How to Determine if it is a Legitimate Business or Ponzi Scheme?

Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, an Italian immigrant who used technique in New England in the 1920's. Although it was he who is most well known for using this scheme, the concept has been around for a long time.

These types of schemes are quite common and you have probably seen those hundreds of times, perhaps without realizing it. They are often in the form of messages that claim that for a relatively small investment, you can make huge amounts of money. There are many variations, but they all are based on the same concept: the promotion of what starts out to be, or appears to be, a real investment opportunity. Many times it involves the development of a valuable resource such as oil, gas, minerals or real estate. In a lot of cases, the resource does actually exist; however, the promoter has significantly overestimated its how much it is worth. In other cases the resource does not even exist. Either way, the promoter convinces investors that the asset can be further developed if they invest into it. In return, the promoter will share the profits with the investors.

The concept works in the beginning and the initial investors do make the huge returns that they were promised. Because of this they are likely to invest more money and recruit new investors. The money being paid out, however, is not coming from the asset, but in the influx of new investors. For this reason, the only way that the investors will continue to get paid is through the continuous reinvestments or investments from new investors. As soon as investing slows down, people stop getting paid and the scheme begins to collapse. When the scheme collapses, most investors lose their money and have no way to recoup their losses. Although Ponzi schemes can last for a fairly long time before collapsing, legal authorities often break them up before they even get the chance because a Ponzi scheme is suspected and/or because the promoter is selling unregistered securities.

The best way to avoid becoming involved in this type of scheme is to thoroughly research any investment before investing into it. If you see: a reliance on funds from new investors to pay commissions, a need for an inexhaustible supply of new investors, and/or absences of a profitable product or efforts to make profits through productive work; there is a good chance that it is indeed a Ponzi scheme.