How to Recognize a Pyramid Scheme or MLM

Published on November 5, 2020

Header Image with Title: How to Recognize a Pyramid Scheme or MLMLet’s say you just got a phone call from a family member or a friend, inviting you to learn more about something they say is an “amazing business opportunity.”

Maybe it came via email, or a direct message on social media. But the message is always the same: “I’ve found a great opportunity to make money, and I can get you in, too.”

Now, in the social media age, most of us know that being approached with a message like that usually means that someone wants us to join their multi level marketing scheme, or MLM. But what many people don’t know is that the message could mean something more sinister: That you’re being recruited for an illegal pyramid scheme.

Many people refer to MLMs as pyramid schemes, and there’s a lot of confusion online about the difference between the two. So how do you know if that friend or family member is approaching you with a legitimate business opportunity, an outright scam, or something that lives in the gray area in between those two options?

As with most topics related to consumers protecting their best interests (and their money), your first line of defense is education. Ready to learn all about how to recognize a pyramid scheme or MLM, and what to do when you encounter them? Read on.

Pyramid Scheme or Multi-Level Marketing?

Graphic showing how Multi-Level Marketing and Pyramid Schemes are different.When it comes to how to recognize a pyramid scheme or MLM, many people struggle to tell the difference. It’s no wonder — they have a lot of traits in common.

According to the Federal Trade Commission, a pyramid scheme is a scam that can look a lot like a legitimate business opportunity or an MLM, but the main difference is that pyramid schemes are set up to keep a constant flow of new recruits (and their money) coming into the business. Because of this, participants will often be heavily encouraged to recruit others (often their friends or family) to join. 

There’s a common misconception that if you’re asked to buy or sell a product, it’s not a pyramid scheme, but that isn’t true — pyramid scheme members are often asked to pay fees or consistently buy small amounts of product to keep their standing in the scheme, even if they still have a large amount of inventory they’ve been unable to sell. 

A multi level marketing scheme, on the other hand, is not illegal. MLM companies sell products or services, and recruit salespeople to market and sell them directly to their friends, families, and networks. MLM participants are usually referred to as “distributors,” “participants,” or “contractors,” and they are not employed by the MLM company — they work as independent contractors.

Participants in MLMs often also struggle to sell enough products to clear their inventory or reach sales goals that will earn them advertised rewards. But according to the FTC, what sets an MLM apart from a pyramid scheme is that, in an MLM, the company will pay its participants just for selling products, and while recruiting new members might help them earn more money, it’s not a requirement for membership.

We’ll go into more detail below about how to recognize a pyramid scheme or MLM, what red flags to look out for, and how to protect yourself from scams and bad business opportunities.

How to Recognize a Pyramid Scheme

Graphic explaining the criteria of a pyramid schemeYou’ve probably realized right now that there’s a lot of gray area here, and even to a practiced eye, it can be tough to spot a pyramid scheme. Luckily, the FTC provides a list on its website of possible warning signs.

If promoters make extravagant promises about how much money you can earn, it might be a pyramid scheme. Whether it’s a pyramid scheme or MLM, your earning potential can be limited by many factors outside of your control, and anyone promising you’ll earn a certain amount is not being truthful.

If promoters use high-pressure sales tactics to get you to join, it might be a pyramid scheme. Often, they’ll play on your emotions (“You’d be a bad dad if you didn’t take advantage of this opportunity to support your family”) or create a false sense of urgency (“This deal will be off the table if you don’t join today”). These kinds of tactics are employed to get people to join without taking the time to research the company. A legitimate business opportunity won’t require you to make any hasty decisions.

If participants buy more products than they can use or sell, it might be a pyramid scheme. Participants will be required to buy a certain amount to stay “active” in the organization, and so even if they already have an excess of inventory, they’ll be forced to buy more. If you see this happening, it’s a major red flag.

What To Do If You Encounter a Pyramid Scheme

If you ever encounter what you suspect to be a pyramid scheme (even if you aren’t 100 percent sure), you can report it to the FTC so they can investigate.

FTC reports can be made online at ftccomplaintassistant.gov. Click “Education, Jobs, and Making Money,” and then select the option to submit a report about “Multi Level Marketing or Pyramid Schemes.” You’ll be taken to a series of forms where you can include all the details you know, so the FTC can decide whether it needs to launch a formal investigation.

Note that the FTC won’t help you resolve an individual dispute, so if you’re looking to get money back after being recruited into a pyramid scheme, this avenue might not help you. But you have options for that, which we’ll explore more below.

How to Recognize Multi Level Marketing (MLM)

The main difference that distinguishes multi level marketing (also called MLM or direct sales) is that members of an MLM won’t be strictly required to recruit new members in order to get paid. They should be paid for selling the company’s products or services, regardless of whether or not they recruit. 

How MLM Participants Make Money

Often, MLMs are set up so participants receive a commission from the products they sell themselves, and then, often a smaller commission from the products sold by participants they’ve recruited (called their downline). 

While this makes it possible to earn money only from the commissions from your own product sales, making a significant amount of money would require selling massive amounts of products, and most people just don’t have customer networks that can support that. And so, in some of these companies, the only way to make significant amounts of money is to recruit many, many people and collect commissions on their sales, too.

Even though MLMs aren’t illegal, the FTC warns on its website that most of the people who join them make very little money, and some even lose money. MLMs are structured so that only a small number of people who join the organization early on can typically recruit enough participants to reach high levels of income and rewards.

Here’s where a Reddit user did the math: Because of the way MLMs are structured, there simply aren’t enough people on earth to support enough recruitment for people outside of the top 2 or 3 levels to reach the highest status, income, and rewards offered by MLM companies. As that Reddit user’s spreadsheet shows, if each member recruited only five new members, within 15 cycles, they’d surpass the entire population of the globe. 

Spreadsheet example of a pyramid scheme from RedditAnd since many people aren’t even interested in joining an MLM, well, you do the math. If you’re lucky enough to be one of the first few sellers/recruiters to join an MLM, you might amass enough of a downline to earn a good living. Any later than that, and it may be actually impossible for you to recruit enough to make a significant income.

Are MLMs Illegal?

According to the FTC, truly legitimate MLMs are not scams or pyramid schemes, and are not illegal.

However, the FTC has filed numerous lawsuits, including several in the last few years, against MLM companies that it says crossed the line and operated as pyramid schemes. 

This highlights an important lesson for anyone considering joining an MLM: Just because an MLM company has been operating for a long time or seems legitimate, doesn’t mean it’s not a pyramid scheme. It’s important to carefully research these companies before joining them, and to temper any expectations you might have about quick success or extravagant earnings.

That isn’t to say that MLMs are bad for all people. Some early joiners do make a lot of money. And some people join just to buy products they love at a discount, or to sell small amounts of product for a side income. MLMs should be approached with caution, and before joining one, you have to be OK with the possibility that you could lose money, or make very little.

Have You Fallen Victim to a Pyramid Scheme or a Scammy MLM?

If you encounter a pyramid scheme, you should report it to the FTC right away. And if you encounter an MLM that’s using shady sales tactics or misleading its members, you should report that, too.

But what about you? If you’ve lost money, or you’re looking for justice after a bad experience with these kinds of schemes, what legal options do you have?

At FairShake, we try to take the power away from big companies and put it back where it belongs: In regular people’s hands. Because of that, we want to hear your complaints about companies like MLMs. 

If you’ve been misled by an MLM or direct sales company, let us know about it. We want to hear your complaints and talk about how we can help you find justice.

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