Watch Out for These MLM Scams & Pyramid Scheme Companies

The allure of starting a business or making a killer investment is something that appeals to many of us. We all want financial security and for that reason, we’re susceptible to offers that are too good to be true. It’s why MLM scams and pyramid scheme companies can do what they do.

You might not know what pyramid schemes and MLMs are, but we’re here to help. We want our Addition Financial members to be successful and financially secure and we know they can’t be if they invest their hard-earned money in a scam. With that in mind, here’s what you need to know about MLMs and pyramid schemes and how they work.

What is an MLM?

A multi-level marketing company, also known as an MLM, is a company that uses a business model that differs from the one used by traditional retailers. While companies such as Target offer their products for sale in brick-and-mortar stores or online, selling directly to consumers, MLMs rely on sales representatives to market and sell its products.

MLMs have been around for decades. The first known MLM was a company called the California Vitamin Company. Founded in the 1930s by a man named Carl F. Rehnborg, the company did not start as an MLM. Carl sold vitamins and other products directly to the public.

In 1939, he rebranded the company as Nutrilite and in 1945, he created the MLM business structure. In an MLM, individual distributors are responsible for marketing and selling products to consumers. They are also expected to recruit other distributors with the promise that they’ll earn commission from the distributors they have brought on board.

Two of the earliest distributors for Nutrilite went on to found another big MLM, Amway. From their earliest days, MLMs have been subject to scrutiny because they sometimes walk a fine line due to their resemblance to pyramid schemes.

MLMs are more popular today than ever before. They attract people who want the opportunity to work for themselves, whether they want to quit their day jobs or just earn a little extra money. The Direct Selling Association, which represents many MLMs, boasts more than 200 member companies. Some estimates say that there are more than 1,000 MLMs in the United States alone.

What is a Pyramid Scheme?

MLM scams have a lot in common with pyramid schemes. A pyramid scheme is one of the oldest types of financial fraud. Simply stated, a pyramid scheme company is usually presented as an investment or earning opportunity. The person at the top of the pyramid recruits people to join in, earning money based on the number of new recruits they bring in.

In a pyramid scheme, the person who initiates the fraud may pay back early investors with the money collected from new arrivals. That’s not always the case. There have been some famous pyramid schemes where nobody made any money. 

We should also mention Ponzi schemes since there is confusion around them. The primary difference between a Ponzi scheme and a pyramid scheme is that, in a Ponzi scheme, people give their money to a portfolio manager to invest. In a pyramid scheme, everybody who buys in is encouraged to recruit more people. The continual recruitment creates an investment pyramid with the initiator of the scheme at the top.

You’ve probably heard of Bernie Madoff, who was behind the biggest Ponzi scheme in modern history. While he lost billions of dollars belonging to his clients, smaller Ponzi schemes happen all the time.

Legit Investment Opportunity or Financial Scam?

What Are the Key Differences Between MLMs and Pyramid Schemes?

Despite the fact that the two terms are often used interchangeably, there are some key differences between MLMs and pyramid schemes that you should understand. 

  1. MLMs focus on selling products. While an illegal pyramid scheme may have a product that individual representatives sell, it is usually an afterthought. An example of an MLM with a product that people have been buying for years is Avon, which sells makeup, skincare products and perfume. 
  2. Pyramid schemes focus on recruitment. While there may be a product for sale, the bulk of the income earned by individual distributors comes from signing up new distributors, not from product sales. In fact, product sales may be negligible when compared to recruitment income.
  3. In some pyramid schemes, new recruits are required to buy training materials or courses to help them learn how to sell the scheme to other people. The initial “investment” they make is a source of income for the person who recruited them.
  4. MLMs usually offer to buy back inventory from individual distributors if they decide to leave. There are exceptions that we’ll talk about in the next section. In a pyramid scheme, there is usually little to no inventory to buy back – or in some cases, the company may simply refuse to buy back inventory under any circumstances.

It can be difficult to tell the difference between a legitimate company and a pyramid scheme because the lines are sometimes blurred. It’s important to ask questions and make sure you understand how the company works before you commit.

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How to Evaluate an MLM

The chances are good that you know at least one person who’s involved in an MLM. They truly are everywhere. Here are just a few examples of well-known MLMs operating in the United States:

  • The Pampered Chef
  • Beach Body
  • Herbalife
  • LeVel
  • Mary Kay
  • Scentsy
  • Nu Skin
  • Jeunesse
  • Amway 
  • Primerica

Many of the people who join MLMs spend all their free time trying to sell products and recruit new distributors. You may have seen them on your Facebook feed or encountered them at PTA meetings or at work.

The key to evaluating MLMs is to ask questions and do research. Here are some things to keep in mind:

  • How distributors make money. If the bulk of their income comes from recruitment, then the likelihood is that you’re looking at a pyramid scheme.
  • How much of their product is sold to the public. Because a lot of MLMs buy back inventory from distributors who leave, it’s important to make sure that those figures don’t account for the majority of their sales. The FTC considers internal sales to be a potential red flag, particularly when there is no buy-back option or when distributors are pressured to buy inventory to advance in the marketing program.
  • How much money distributors earn. It’s important to weigh your initial investment against your potential earnings. While most MLMs promise big earning potential, the reality is that most distributors earn very little.
  • The quality of the products being sold. While some MLMs have high-quality products that have remained popular for decades, others sell products that generate quality complaints on a daily basis. If the products aren’t good, there is little chance that you will earn money selling them in the long term.

We always want Addition Financial members to be skeptical and ask questions about any money-making or investment opportunity. No legitimate business opportunity will vanish because you ask to verify information or want to look at numbers before getting involved.

An MLM Cautionary Tale

There are some well-documented MLM cautionary tales that you should keep in mind before joining one and spending your hard-earned money on products to resell. 

The MLM we’re going to share is one you may have read about in the news. LuLaRoe is an MLM that recruits individual distributors to sell women’s clothing in modest but colorful styles, such as leggings and shirts. The company was founded in 2013 and by 2017, it had more than 50,000 distributors. The problem was that the company’s success was an illusion.

Behind the scenes, the company’s founders were pressuring distributors to put their profits into buying more inventory, encouraging them to max out their credit cards, take out loans and in one case, suggesting that a distributor sell her breast milk to buy more products.

By 2018, the company was besieged with multiple lawsuits, including one that alleged the company owed $49 million to its primary supplier. Earlier this year, the company was ordered to pay a $475 million settlement in a Washington lawsuit. 

To illustrate the point about earnings, let’s take a quick look at LuLaRoe’s income disclosures, which they are required to list on their website. As of 2020, the company said the following:

  • Only 14.62% of distributors received any compensation through their Leadership Compensation Plan.
  • The average earnings for those who did make money amounted to only $1,235.97 while the median earnings were $0.
  • Even retailers who sold LuLaRoe products earned practically nothing, with the median income coming in at just $1,444.65.

As you can see, those aren’t impressive numbers. They look even worse when you realize that many of the people who bought LuLaRoe products to sell got stuck with tens of thousands of dollars of low-quality inventory that they had to sell at a loss.

Not all MLMs are pyramid schemes and some have products that people love, such as Tupperware, Avon and Mary Kay. If you do decide to start a business by joining an MLM as a distributor, we hope you’ll use the information we’ve provided here to do some due diligence before you spend your hard-earned money.

Joining an MLM isn’t the best way to secure your finances for the future. Click here to learn about the Addition Financial retirement accounts.

The content provided here is not legal, tax, accounting, financial or investment advice. Please consult with legal, tax, accounting, financial or investment professionals based on your specific needs or questions you may have. We do not make any guarantees as to accuracy or completeness of this information, do not support any third-party companies, products, or services described here, and take no liability or legal obligations for your use of this information.