MLM vs. Pyramid Scheme: How to Tell Them Apart (and Avoid a Scam)

Millions of people have chosen to start a new business by participating in multi-level marketing (MLM) opportunities. In fact, AARP reported that more than 20 million Americans have been involved with an MLM at some point in their lives, generating over $36 billion in retail sales.

Although there are legitimate MLM businesses, many companies have been compared to pyramid schemes, and some have even run into issues with regulators. Worse, millions of people who have become MLM sellers with the dream of generating extra cash or launching a new career have ended up losing money instead. In a 2018 AARP study, only one quarter of survey respondents reported making any profit at all during their involvement with an MLM, while 47% of MLM participants reported losing money from their venture.

That’s a sobering statistic. So how are you supposed to know whether the company you’re looking at is legitimate or a scam? Should an MLM even be on your list of ideas when you’re considering how to make extra cash?

If you are thinking of becoming part of an MLM business, here’s what you need to know about MLM vs. pyramid scheme business models.

How an MLM works

With most businesses, you buy a product directly from a company or at a store. But MLMs function differently. If you want a product that an MLM sells, you have to buy it from an authorized MLM seller or distributor; you can't just go to a store or website to buy the product. The MLM industry on the whole offers a wide range of merchandise, such as supplements, makeup, candles, cookware, and cleaning products. If you’ve been to a party at a friend’s house that revolved around buying from a line of products, then you’ve probably been exposed to an MLM.

To become an MLM seller or distributor with a particular company, you usually need to pay a fee and buy a set amount of inventory to get started. For example, as of February 2020, to become a LuLaRoe independent fashion retailer, you need to spend $499 on an initial inventory order. That order gives you 65 different pieces to sell and gives you access to LuLaRoe’s educational, marketing, and sales tools. But, although the company may provide you with tips and advice on how to run and market your business, you run it independently and are solely responsible for its success.

There are two ways you can make money with an MLM:

• By selling products to customers
• By recruiting new sellers and earning commissions on their inventory purchases and customer sales

Many companies promote earning commissions from your “downline” — also known as the sellers you recruit to sell under you — as a way to make more money. When you recruit new sellers, you get a percentage of any sales that they make. For example, if you are a SeneGence distributor and recruit other distributors, you’ll earn a 10% commission on all of their sales in addition to what you earn on your own sales.

What is an MLM scheme?

There are some MLM companies that are reputable and have operated for a long time. For example, Tupperware Brands has been around for decades and has more than 3 million salespeople. Who hasn’t heard of a Tupperware party, right? Or the Avon lady? Yes, she’s part of an MLM too.

Unfortunately, there are other MLMs that border on pyramid schemes or are outright illegal. How can you spot the difference? The Federal Trade Commission (FTC) lists the following as the biggest red flags:

1. The company says you can change your life. To recruit you, the company may tell you that you can quit your full-time job and become rich by becoming an MLM seller.
2. A substantial part of your income is based on your downline. With a legitimate sales company, your income depends on how much product you sell. But with a pyramid scheme, your income is based on your downline, which means how many other sellers you can recruit.
3. You’re encouraged or required to buy more products. Some MLM schemes will encourage or require you to purchase more inventory, even if you already have more products than you can sell. Without doing this, you may be unable to maintain your status as a seller, get paid, or qualify for bonuses.
4. You have to pay extra fees. Some companies will charge you fees for training sessions or marketing materials. Although these sessions aren’t strictly required, the companies may imply that they’re necessary for your success.
5. They apply serious pressure. MLM schemes may use high-pressure sales tactics to play on your emotions to get you to sign up, discouraging you from taking time to do research on the company.

If the companies display some or all of the above red flags, even if regulators haven’t yet identified them as a pyramid scheme, they should be avoided.

MLM vs. pyramid scheme

Some people use the terms MLM and pyramid scheme interchangeably, but they’re very different. So what are pyramid schemes, exactly?

With pyramid schemes, the primary source of revenue is through recruiting new members rather than product sales. The company promises high returns in short periods of time, and they often promote themselves through social media, group presentations, and conference calls.

Because the companies’ revenues are based on new recruits, they’re constantly trying to bring on new members. However, that business plan is unsustainable and the pyramid scheme eventually collapses, which leaves the people at the bottom of the pyramid unable to recoup their money.

Pyramid schemes are illegal and are investigated by the Securities and Exchange Commission and the FTC. The first investigations and subsequent legal cases began in the 1970s, and both agencies have continued to pursue illegal pyramid schemes ever since.

Despite these efforts, pyramid schemes continue to operate, and have affected millions of people. Three major cases that have occured in the past few years involved AdvoCare International, Herbalife, and Vemma.

AdvoCare International

One of the most well-known and recent cases of a pyramid scheme is AdvoCare International, a health company that sold energy drinks, protein shakes, and supplements. It was a popular and well-known company that had Drew Brees, the quarterback of the New Orleans Saints, acting as a spokesperson.

In October 2019, AdvoCare paid $150 million to settle charges that it operated an illegal pyramid scheme. According to the FTC, 72% of AdvoCare’s distributors lost money or made no money, and an additional 18% earned less than $250 per year. After subtracting the distributors’ expenses, nearly all of them lost money.

Herbalife

Another major case involved Herbalife, a seller of shakes and supplements. The FTC said Herbalife misled customers, convincing them they could earn a substantial amount of money selling products. In actuality, the FTC claimed that distributors were rewarded for recruiting other sellers rather than selling products.

Herbalife agreed to restructure its business operations and paid $200 million to compensate customers and settle the FTC’s charges.

Vemma

Vemma stood out as an MLM because it targeted college students and young adults as distributors. In its marketing materials, it showed its distributors surrounded by signs of extreme wealth, such as yachts and luxury cars, to encourage others to become sellers.

In 2015, the FTC brought federal court action against the company. In its complaint, the FTC said Vemma encouraged sellers to buy more products to qualify for bonuses and told other recruits to do the same. As a result, people were primarily compensated for recruiting other sellers rather than selling products.

In December 2016, Vemma ended its business practices and agreed to pay a $238 million judgment.

Can an MLM be legit?

Yes, there are some legitimate MLM opportunities out there. And if you’re a customer of a particular company and personally enjoy their products, becoming a MLM distributor can help you score a discount on those products and earn extra money on the side.

However, it’s important to do your due diligence before committing your time and money. Choosing the right company could lead to success; choosing one that’s a scam could be a serious side hustle mistake.

What to watch out for before joining an MLM

• Look up company complaints. Before signing up as a distributor, do your homework online and see whether any complaints exist. Do a search for the company’s name on SEC.gov, FTC.gov, and also check with your state attorney general.
• Check out distributor reviews. Look for reviews from sellers and distributors on Glassdoor and Trustpilot to get a firsthand perspective from other people like you.
• Review the product’s value. Make sure you are confident in the product’s value and pricing. If the product is high-quality and reasonably priced, you’ll have an easier time selling it. But if it’s questionable or makes too-good-to-be-true claims, that should be a major red flag.
• Understand the startup costs. When you sign up to become a distributor, you often need to pay a fee and purchase inventory. You may also need to buy training and marketing materials or even attend in-person seminars. All things considered, it can cost hundreds or even thousands to get started. If that doesn’t work for you, there are plenty of other businesses you can start for $1,000 or less.
• Ask about the company’s refund policy. With some companies, you can return unsold merchandise and get a full or partial refund. With others, there are no refunds offered at all. Before purchasing any inventory, make sure you understand the company’s refund policy and that you are okay with it.
• Request financial disclosures. Don’t trust another seller’s claims when it comes to potential earnings. Request the company’s financial disclosures and see what the average seller earns. If the company won’t send you this information, walk away.

Questions to ask yourself before joining an MLM

Even with a legitimate MLM opportunity, direct sales aren’t for everyone. Before spending your hard-earned money becoming a distributor, ask yourself the following questions:

• Do you enjoy selling? Working in sales requires you to be outgoing and direct. If approaching acquaintances and complete strangers to sell products makes you uncomfortable, becoming a MLM distributor probably isn’t for you.
• Do you have the time? Legitimate MLMs are not get-rich-quick schemes; they require serious commitments. You’ll have to spend hours coming up with business plans, marketing your products, and cultivating customers.
• Can you afford the risk? Unlike some of the best side hustles that don’t have any startup costs, MLMs typically require you to invest hundreds or even thousands of dollars. If you’re short on cash, starting an MLM can be extremely risky.

Alternatives to an MLM

If joining an MLM sounds too scary or intimidating, we have some other tips for how to make money that aren’t so risky:

• Sell things online. If you love the idea of working in sales, consider becoming a reseller. You can sell clothes, shoes, and accessories online. You can sell your own used items or thrift store finds on sites such as eBay, Poshmark, and Tradesy.
• Rent out your car. If you have a car you don’t use every day, you can turn it into a money-making machine by renting it out. Tourists and locals in need of a ride can rent your car when they’re in town. You can rent out your vehicle on Turo or Getaround.
• Make deliveries. If you don’t mind grocery shopping, you can make $15-20 per hour delivering groceries with Shipt or Instacart. Or you can deliver food by partnering with a service such as Postmates or DoorDash.
• Give tours. If you know your town inside and out, make money by giving tours to visitors and showing them the biggest hotspots and little-known gems. Find clients by becoming a tour guide on ToursByLocals or Alphlex.
• Tutor. You can make money online tutoring students in subjects such as English, chemistry, and algebra on sites like Tutor and Chegg. You can make $20 per hour and more.

Bottom line on MLM schemes

When it comes to whether a company is an MLM vs. pyramid scheme, the line can be blurry. Before becoming involved in a company, make sure you do your homework and thoroughly research it so you don’t waste your time or hard-earned money. If you do decide to become a MLM seller, pick a product you love, come up with a marketing plan, and be prepared to hustle to make your new business a success.