Avoiding Pyramid Schemes

Pyramid schemes have existed for at least a century, and one reason they've proven so durable is their attractive proposition. In exchange for paying to join an organization, new members are promised a percentage of any money generated by everyone they recruit.

If that sounds good in theory, it rarely works out that way in practice. Companies using true pyramid schemes seldom sell anything of value and, instead, rely on the scheme's structure to generate incoming revenue. Once people realize they've been duped, the money dries up, and all those initial investments are never recouped.

So just avoid pyramid schemes, and you'll be fine, right? Not so fast. Pyramid schemes aren't always immediately identifiable and share some overlapping characteristics with another common business structure, multi-level marketing.

Pyramid Schemes Versus Multi-Level Marketing?

Like traditional pyramid schemes, multi-level marketing structures require participants to recruit others in exchange for a percentage of the profits generated by those new participants. Prominent companies that use this structure include Amway and Herbalife. However, there are two key legal distinctions between multi-level marketers and pyramid schemes: multi-level marketing companies don't charge a joining fee and generally sell products of significant value.

Pyramid schemes typically exhibit these characteristics:

• Focus primarily on recruitment rather than product sales.
• Promise high returns with little effort.
• Offer complex commission structures that benefit those at the top.
• Require substantial upfront investments.
• Often, they collapse quickly, leaving most members with losses.

The key feature of a pyramid scheme is its unsustainability. The business model relies on an endless chain of recruitment, which is mathematically impossible to maintain. Eventually, the pool of potential recruits dries up, and the scheme collapses. Those at the bottom of the pyramid – typically most participants – lose their investments.

In contrast, legitimate MLMs usually have these traits:

• Emphasize product sales to non-network members.
• Offer realistic income projections.
• Provide clear, straightforward compensation plans.
• Have minimal startup costs.
• Maintain long-term sustainability.

Some prominent multi-level marketing firms have been taken to court and charged with being pyramid schemes. Courts, however, have typically found that by not charging distributors and selling valuable products, these marketers have stayed within the bounds of the law.

That doesn't necessarily mean that multi-level marketing is a great business proposition. Much like with illegal pyramid schemes, those at the top of the distribution chain make the vast majority of profits. New distributors often find the rewards much more modest as they attempt to recruit new people while selling products.

Additionally, some multi-level marketers have been criticized for focusing their efforts on people with low incomes. Economically vulnerable people are often especially susceptible to inflated claims about the potential to make large sums of money. These claims are only realized if they can recruit significant numbers of distributors to work under them.

The key to distinguishing between a pyramid scheme and a legitimate MLM lies in understanding the primary source of revenue. If it's recruitment, be wary. If it's product sales to genuine customers, it's more likely to be legitimate.

Important Considerations

If you're considering a business arrangement but are unsure about whether it's legitimate, ask yourself the following questions:

• Am I being asked to provide a joining fee? Or a fee for the right to distribute the product? If the answer is yes, be wary - this is one of the legal distinctions that establishes a pyramid scheme.
• Does the company sell a legitimate product? If the answer is no, then both primary qualifications for pyramid scheme status have been met. Proceed with extreme caution - or even better, walk away.
• Will I make most of my money via sales or by recruiting distributors? Sales are generally a much more reliable revenue generator than distribution royalties. While the idea of becoming wealthy through the work of others is undeniably enticing (and one reason for the enduring popularity of pyramid schemes), it rarely works out that way.

The Takeaway

While the promise of easy money can be tempting, it's crucial to approach any business opportunity with caution and skepticism. Pyramid schemes, whether blatant or disguised as MLMs, often lead to financial loss and personal distress for most participants.

Before investing time or money in any opportunity, do your research, understand the business model, and consider seeking advice from financial professionals. Remember, sustainable financial success only comes with effort and time.