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Is it a Pyramid Scheme, a Ponzi Scheme or Legitimate MLM?

From the Editor's Desk
Jan 21st, 2015
  • 2 min read
  • Hummy's
    Highlights

    1Not all MLMs are pyramid schemes, but some are. 2Ponzi and Pyramid schemes are always illegal. 3Beware of vague "get-rich-quick" promises.
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At some point you’ve probably been offered an opportunity to take part in a multi-level marketing company by a friend. When some people hear about this business model, they automatically assume that it is a scam, or incorrectly confuse the concept with a pyramid scheme.

A recent article by Investopedia, published on Forbes.com breaks down the definitions of each so that you can distinguish for yourself what it is that you’re being invited to be part of.

Pyramid Scheme

Leadership-Flying geese in V formation led by white gooseA pyramid scheme is always illegal and designed to defraud unsuspecting investors out of their money. The article illustrates that the first person to start recruiting people to be part of the pyramid scheme sits at the top of the pyramid.

“This person recruits a second who is required to ‘invest’ a certain amount, which is paid to the initial recruiter. In order to make his or her money back, the new recruit must recruit more people under him or her, each of whom will also have to invest,” the article explains.

Each new recruit in the pyramid scheme is required to recruit 10 more, and each of those 10 must recruit 10 more. Sometimes these plans are mis-represented as gift-giving exchanges, to mask their illegality.

Ponzi Scheme

Similar to this is a Ponzi scheme, which relies on a stream of cash from new “investors” to pass along fake profits to pay off old investors. In both cases, 90% of the investors will lose all of what they put in.

Multilevel Marketing Scams

The article points out that although some MLM companies can be fraudulent schemes, not all are. Legal multilevel marketing (MLM) also has a structure that encourages you to recruit other representatives, but it may in fact be a legitimate business, not a pyramid scheme. MLMs typically offer you a percentage of the sales revenue generated by the members you’ve recruited, in addition to compensation for your own product sales.

In the more recognizable MLM scams, the product itself has no inherent value, such as a mailing list or report. “In this kind of pyramid scheme, you would be required to recruit new members into the MLM in order to make a profit and keep the MLM alive. Joining the MLM is the only reason anyone would buy the products sold by this pyramid scheme,” the article states.

However, even the MLMs that sell actual products such as cosmetics or supplements can also be pyramid schemes.

In Conclusion

When in doubt, ask the tough questions before entering into any investment. Be particularly cautious when offered a ridiculously high rate of return and a vague or non-existent explanation of how your funds are going to be invested, the author concludes.

To read the original article in its entirety, please visit Forbes.com.

 

About the Author

From the Editor's Desk

This article was written by a bizHUMM Staff Writer. We aim to provide practical tips that help solve your burning small business questions. If you have any suggestions or ideas for articles, please email them to: editor@bizhumm.com