You really must feel sorry for the guy, forced to stay locked up in a 12-room penthouse in Manhattan.

The World’s Largest Ponzi Scheme

Madoff created the world’s largest Ponzi scheme also called a pyramid scheme, paying long-time investors with new investors’ money. And year in and year out, including 2008, a year in which we watched stocks plummet 35% on average, Madoff’s early investors continued to see an average annual gain of 9%. Bernie Madoff was a stock-picking genius!

Here’s the thing. Madoff made his name as the head of the National Association of Security Dealers – the NASD in NASDAQ. Now, wouldn’t you trust your investments to the one-time head of the NASD? No brainer, right?

“Oh, what fools these mortals be.” William Shakespeare

Oh, yeah, they were lining up – throwing money at Madoff. And who are they? Smart money, professional investors that’s who. You know who got stung in this scam. Movie producer, Steven Spielberg, long-time New Jersey Senator Frank Lautenberg, university endowment managers, charities including a children’s hospital!

Even the Securities and Exchange Commission (SEC), which is supposed to provide stock market oversight, and first began investigating Madoff in 2003, missed the boat on this one.

Just north of New York City, in the state of Connecticut, there are some of the most wealthy communities in the world. Towns like Greenwich, Stamford, Westport and Fairfield. Old money towns referred to simply as The Gold Coast. Tonight, people who were multi-millionaires living in “deluxe accommodations,” sipping expensive champagne and driving their Hummers, are now totally broke.

Now, let me state this once again because it’s key. The people who invested with Madoff are experienced, professional money managers. Even the stock police couldn’t ferret out this weasel. In fact, his own family finally pulled the plug on Bernie, even though they all worked at Madoff’s NYC HQ. That’s how bad it got. The guy’s own family turned Madoff in to authorities. How egregious does a fraud have to be to have your own, well-paid family call the authorities? You start to get the picture.

Take a Lesson from Bernie

I always learn from my own mistakes and the mistakes of others, looking for lessons in human nature, and Mr. Madoff’s prodigious Ponzi plan provides all small business owners with some take-away lessons.

1. Trust no one ... until

Indeed, it’s a cynical but necessary approach to small business development. I’ve encountered my share of ambiguous, ethically challenged people in all sectors of business.

Madoff certainly had the credentials to build trust and that’s what he did as he stole from children’s charities. So, check the references provided by a potential new hire. In fact, check the entire employment portfolio. Same with vendors, sub-contractors and out-sourcers.

Once you’ve developed a business relationship based on performance, trust will follow organically.

2. If you don’t understand it, don’t do it.

Madoff was selling “derivatives,” “structured debt instruments” and other totally off-the-wall “investments” in order to deliver that 9% average annual return. Problem is, even investment experts and professional money managers bought in to these unusual investments. After all, if the former head of the NASD says it’s a good bet, it must be a sure thing.

As a small business owner, you’re hit from all sides with companies that offer call-capture services, lead generation, marketing data and other hard-to-quantify, somewhat ephemeral software, for example. Now, some of these packages and services are useful to small businesses.

However, I run in to client businesses that bought a $10K Content Management System (CMS) for their miniscule website selling doilies and antimacassars. They were told that this would be a money-making-time-saving-margin-expanding tool that now sits on the hard drive unused and taking up valuable network space.

If you don’t understand the benefits and/or the features – ask questions. Most of us fear appearing foolish, out-of-step or just plain stupid by asking questions. “Of course I understand the need for a $10K CMS. I didn’t fall off the turnip truck yesterday, you know.”

Don’t let your pride get in the way of making the right decisions for your business and its future. If you don’t understand it – from end-to-end and top-down, don’t buy it, don’t engage it, don’t sign up for it and certainly don’t write a big fat cheque for it.

3. Don’t put all of your eggs in one basket.

An oldie but a goodie for both personal investing and growing a business.

If you allocate your entire marketing and promotion budget to adverts in the local newspaper, how can you compare returns versus, say, a bigger advert in the Yellow Pages? Or adding a website to your Main Street service business?

4. Protect what you’ve got.

In the personal investment orbit, this is called preservation of capital.

In the commercial realm, your capital includes money in the bank, perhaps the building that houses your office, office equipment and other “things.” But, your capital also includes your business’ reputation, its local perception as a good corporate citizen, your existing client base and word of mouth marketing.

Preserve all of your business’ assets – both the 3-D and intangible assets you’ve worked so hard to create and assemble.

5. And the final lesson I take away from the Madoff debacle? Expect the unexpected.

At the beginning of this year, if someone had told you that asset growth would be down in the range of 35%, you’d have labeled this soothsayer an over-caffeinated bear and a doom monger.

Yet, here we are, facing the first global economic meltdown in history. The world has become so small, our economies so entwined, that we are certainly in uncharted waters. Agreed?

So, keep a life raft handy. Know where the exits are when you enter the deal. Stay current on best business practices (changing daily thanks to the world wide web) and keep an eye on your wallet.

©Michael Harrison 2008