Are you considering a business opportunity that involves selling products to family and friends and recruiting other people to do the same? That kind of business is called multi-level marketing (MLM) or network marketing. Some MLMs are illegal pyramid schemes.
People who become involved in an illegal pyramid scheme may not realize they’ve joined a fraudulent venture, and typically lose everything they invest. Some also end up deeply in debt. Here’s what you should know about MLMs and pyramid schemes, along with what you should do before joining an MLM program.
What are MLMs and How Do They Work?
MLM companies sell their products or services through person-to-person sales. That means you’re selling directly to other people, maybe from your home, a customer’s home, or online.
You can find more information in this article: What is an mlm?
If you join an MLM program, the company may refer to you as an independent “distributor,” “participant,” or “contractor.” Most MLMs say you can make money two ways:
- by selling the MLM’s products yourself to “retail” customers who are not involved in the MLM, and
- by recruiting new distributors and earning commissions based on what they buy and their sales to retail customers.
Your recruits, the people they recruit, and so on, become your sales network, or “downline.” If the MLM is not a pyramid scheme, it will pay you based on your sales to retail customers, without having to recruit new distributors.
What’s a Pyramid Scheme and How Do You Spot One?
Pyramid schemes are scams. They can look remarkably like legitimate MLM business opportunities, but if you become a distributor for a pyramid scheme, it can cost you and your recruits – often your family and friends – substantial time and money.
The promoters of a pyramid scheme may try to recruit you with pitches about what you’ll earn. They may say you can change your life – quit your job and even get rich – by selling the company’s products. That’s a lie. Your income would be based mostly on how many people you recruit, not how much product you sell. Pyramid schemes are set up to encourage recruitment to keep a constant stream of new distributors – and their money – flowing into the business.
Often in a pyramid scheme, you’ll be encouraged or even required to buy a certain amount of product at regular intervals, even if you already have more inventory than you can use or sell.
You may even have to buy products before you’re eligible to be paid or get certain bonuses. You also may have to pay repeated fees for other items, like training sessions or expensive marketing materials. In addition, the company may say you can earn lavish rewards, like prizes, bonuses, exotic vacations, and luxury cars. However, it often turns out that you have to meet certain product purchase, recruitment, training, or other goals to qualify for the rewards, and only a handful of distributors ever qualify.
Eventually, most distributors find that no matter how hard they work, they can’t sell enough inventory or recruit enough people to make money. They also can’t keep up with required fees or the inventory purchases they need to make to qualify for rewards, and they can’t earn enough money to cover their expenses. In the end, most people run out of money, have to quit, and lose everything they invested.
Here are some warning signs of a pyramid scheme:
- Promoters make extravagant promises about your earning potential. Stop. Such promises are false.
- Promoters emphasize recruiting new distributors for your sales network as the real way to make money. Walk away. In a legitimate MLM program, you should be able to make money just by selling the product.
- Promoters play on your emotions or use high-pressure sales tactics, maybe saying you’ll lose the opportunity if you don’t act now and discouraging you from taking time to study the company. Leave by the nearest exit. Any company that tries to pressure you to join is one to avoid.
- Distributors buy more products than they want to use or can resell, just to stay active in the company or to qualify for bonuses or other rewards. If you see this happening, keep your money.
Is an MLM Right for You?
If you’re considering joining an MLM, know that some MLMs – even ones that aren’t pyramid schemes – may not be a wise investment. Other MLMs may not be a good fit for your interests and lifestyle. Here are some tips to help protect yourself against a bad MLM experience:
Ask yourself these questions:
- Do you want to be a salesperson? If you join an MLM, you’ll be a salesperson. Your job will be to sell the company’s product and, in many cases, to convince other people to join, invest, and sell. If you don’t like selling, or if you’re uncomfortable asking people you know to put their time and money into a business venture, joining an MLM is a bad idea.
- Do you have a solid sales plan? Consider whether you have friends and family who will buy this product from you over and over again. Think about how you would find and keep other regular customers. Can people buy something like this product elsewhere, maybe for less?
- What are your income goals? You might think that, with your smarts and hard work, you can earn substantial income through the MLM. In fact, most people who join MLMs and work hard make little or no money, and some of them lose money.
- Can you afford to risk the money and time? Every business venture has risks. MLMs are no different. Even if the start-up costs seem low, additional expenses can add up quickly. Expenses can include training and travel costs, website fees, promotional materials, costs to host parties, and costs to buy products. If you need to borrow money or use your credit card to finance your expenses, you may face hefty interest charges too. Also, consider the time demands of the business, like going to training, recruiting new distributors, managing paperwork, recording inventory, and shipping products.
Do your homework:
- Research the company. Search online for the name of the company and words like review, scam, or complaint. You may also want to look for articles about the company in newspapers, magazines, or online. Does the company have a good reputation for customer satisfaction? Check with your state Attorney General for complaints. A lack of complaints doesn’t guarantee that a company is legitimate, but complaints can tip you off to possible problems.
- Research what distributors are saying. Individual distributors often post their own training videos online to promote the MLM. Search for these materials. Be suspicious if the training makes earnings claims, tell you that the fastest way to make money is to “recruit, recruit, recruit,” or suggest that all you need to do to build a downline is “find two people who find two people.” Claims like these are hallmarks of a pyramid scheme.
- Consider the products. MLM companies may sell quality items at competitive prices. But some offer goods that are overpriced, have questionable benefits, or are downright unsafe to use. For example, be very skeptical about health products advertised as having “miracle” ingredients or guaranteed results. Those claims are generally false or at least unproven and, at worst, the products could be dangerous.
- Understand the costs. Many MLMs make you buy training or marketing materials, or pay for seminars on building your business. You may need to book travel and pay for hotels and meals. Make sure you know what you must pay for, and how much it will cost over time. If the company says some of these things – like periodic product purchases or training – are optional, find out if you’ll become ineligible for bonuses or rewards if you opt out of them.
- Ask about refunds. In many MLMs, before you can start selling the products, you have to buy them from the company. So get the company’s refund policy in writing. Make sure it includes information about returning any unused products, including restrictions and penalties. Consider whether you’ll get a full refund or only a partial one — and how long it may take.
- Read the paperwork and have a friend or advisor review it. Read the company’s sales literature, business plan, disclosure documents, and any contracts or agreements you’ll need to sign. Ask an accountant, a lawyer, or someone else you trust – and who is not affiliated with the company – to help you review the MLM’s materials. Ask them to look at your possible earnings and whether the company can back up its claims about how much money you can make. Ask for their honest opinion about whether they think the MLM is legitimate and a good fit for you.
Talk with current and past distributors about their experience in the MLM:
Ask tough questions and dig for details. Don’t consider it nosy or intrusive: you’re thinking about starting a small business. A good business person needs those answers.
Here are some questions to ask:
- How long have you been in the MLM?
- How much money did you make last year, after expenses?
- What were your expenses last year?
- Have you borrowed money or used your credit card to fund your business? How much did you borrow? How much do you owe?
- Do you need to have recruits to make money?
- How many people have you recruited? How many did you recruit last year?
- How many of your recruits have left the business?
- What percentage of the money you made came from selling the product to customers outside the MLM?
- What percentage of the money you made – income and bonuses less your expenses – came from recruiting other distributors and selling them inventory or other items to get started?
- How much time do you spend on the business?
- How much inventory did you buy from the MLM last year? Did you sell all of your inventory?
Remember, you’re on a mission to check out a potential business deal that will require your time and money. The information you learn can help you decide whether it’s really a deal, a dud, or straight up illegal.
What’s the difference between an MLM and a pyramid scheme?
10 Signs a Business Is an MLM Scheme:
No or Low-Quality Product or Service
There are many red flags that should warn you away from a business or financial opportunity, but the biggest is a lack of a product. Programs that push recruiting over the sales of a product or service might be a pyramid scheme. If a company isn’t focused on acquiring more customers to buy its products, but rather it’s interested entirely in “building a team” or membership of sales reps, consider it a red flag.
The foundation of any good MLM business is about getting products and services to end consumers. While building a team can be a part of that, income is based on goods sold by the team, not in the recruiting itself.
Outrageous and Unfounded Product Claims
Wild claims is seen most in health and wellness companies in which reps boast that their products cure ailments or work miracles. Outlandish hype is a red flag in any industry, including direct sales.
A successful business is founded on quality products. If the company you’re considering joining has bizarre products or products that seem too good to be true, use caution. The last thing you want your name tied to is a faulty product or a product which is the focus of litigation.
High-Pressure Sales Tactics
The most common high-pressure tactic is the lure of getting in on the ground floor. But in direct sales, a good opportunity is a good opportunity no matter when you get in. In fact, you’re safer to go with a company that has been around for more than five years (the longer the better) than a start-up.
Any effort a representative makes to prevent you from studying the company, talking to others, or “sleeping on it” isn’t someone you want to work with.
Pressure to Buy and Stock Inventory
All MLM businesses will have some start-up costs. You can’t buy a McDonalds without investing money, and the same is true for direct sales, although it is much less expensive.
What you want to watch out for are fee-based “fast track” programs or pressure to have inventory that requires additional investment. Due to this practice, the law now requires MLM companies to buy back inventory, but that doesn’t mean you want to be saddled with debt before you start and truly understand the business.1
Having a few popular products on hand can be nice, but don’t fill your garage with products unless you know for sure, based on your experience in the business, that you can sell them.
Poor Company Communication
Don’t be afraid to ask hard questions. If you don’t get solid answers or are chastised for not being a positive thinker or believing in the company, consider it a red flag.
In order to be successful at any business, you need strong support and solid training. The law requires MLM companies to give you a slew of information, details about the compensation plan, and financial information about average income earned by reps.2 Study this and ask questions. If the rep is hesitant to answer your questions or glosses over your concerns, he’s not someone to work with. A legitimate company wants you to be informed
Expensive On-Going Training or Other Business Items
Some Amway reps got into a bit of hot water for the sales of tapes they (the reps) created and sold. Most representative teams and the companies have free training either locally and/or online. While they may also have additional training (i.e., audio or videos) that you can buy, there shouldn’t be pressure to do so.
Further, most companies have an annual convention, which can be fun and informative, but expensive to attend. If a company routinely pressures you to pay for training this is another red flag.
Poor Better Business Bureau Rating
Truthfully, this is a difficult marker because the BBB routinely marks home business opportunities low simply because they’re involved in working at home, not based on any investigation. However, you can see if there are complaints and how the company dealt with them. If a company is responding to and fixing problems (all companies in every industry will have customer service issues), that’s a good sign. However, if they fail to respond or offer help, that is a red flag.
Deceptive Advertising Practices
Some MLM reps will promote their business as a “job” or use other descriptions to lure prospects. MLM isn’t a job, it’s a business. Any MLM rep promoting “employment” is using deception and isn’t someone you want to work with.
Other deceptive (and often illegal) practices include making income guarantees or suggesting you’ll make money doing very little work.
Cryptic “Job” Interview
Another issue that Amway and other companies were dinged for was how reps would lure people into coming to a “meeting” to hear how they could “leverage time and money.” Many reps and companies know people are leery of and have many misconceived notions about MLM, so they use deception to get prospects to hear their spiel.
However, many legitimate companies, working to safeguard their brand, don’t allow reps to advertise their name. This practice means reps have to find a way to entice people to learn about them without saying the company name, which can seem suspicious.
The important thing for you to remember is to follow your gut feeling. Good reps from legitimate companies that are prevented from using a company name in promotions are usually able to provide some idea about the business, including the company name, when talking to you in person or on the phone, and are clear that it is a business. Anything else should be suspect.
Mindy Lilyquist, a home business expert who was once scammed by an MLM, said she had a bad feeling about the business right away.
“From day one, I failed to acknowledge the biggest sign that something wasn’t right – my gut,” she said. “I felt unsettled from the moment I walked into my so-called interview to the moment I no longer had ties with the company. In further hindsight, the other representatives also displayed unease.”
The lesson here is to not dismiss your intuition. If it doesn’t feel right, scam or not, it’s not for you. If you feel coerced or conned, then it’s definitely not for you.
Other Things to Consider
While some of these 10 items are flags of a scam, some, such as unsettled feelings, aren’t necessarily a scam but are an indication that the home business opportunity isn’t for you. You can avoid a lot of mistakes and build a successful direct sales business by investigating the company, choosing a product or service you can get behind, and having a belief in the product, company, and system
If it’s too late, and you think you’ve been scammed, there are some things you can try to get your money back, including contacting your bank and reporting the business to the secretary of state in the state the company’s home office is located. You can also file a complaint with the Federal Trade Commission.