Whether it’s from a random stranger on social media or your own investment research, knowing how to distinguish between an MLM vs. pyramid scheme can keep you and your money safe. Some will tell you they offer lucrative opportunities for growth while others warn you about their legality and exploitative nature. What is the difference between MLM and pyramid schemes?
Our business experts here at Business2Community have prepared this detailed comparison to address the issue. We’ve broken down the core features of MLMs and pyramid schemes so you can make smarter and more informed business decisions by choosing the right business model.
MLM or Pyramid Scheme – Key Differences
- In the US, pyramid schemes are a criminal offense and the defendant can face fraud charges, whereas MLM businesses are fully lawful and legitimate and can operate and even become publicly listed like other companies.
- A key difference between MLM and pyramid schemes is that MLM emphasizes sales to boost your commissions and a pyramid scheme often rewards you simply for bringing in new distributors/recruits.
- MLM companies like Nu Skin, Business In Motion International, and Herbalife, have faced court charges and were ordered to pay a fine for running a pyramid scheme, illustrating the complexity of separating the two operational strategies.
Pyramid Scheme vs. MLM – What’s the Difference?
A pyramid scheme is an illegal business model that focuses on having you recruit people and rewards you with a percentage of the income from those you bring in, without a focus on a product to sell. Meanwhile, an MLM is a legal way to do business where you sell products and are encouraged to bring in your own distributors to receive a cut of their sales. The biggest differentiator is pyramid schemes focus on recruitment while MLMs focus on product sales (with some recruitment on the side).
Multi-level marketing, or network marketing, and pyramid schemes can seem like an easy way to find more business partners and grow your own business. For inexperienced investors, distinguishing between legitimate MLM businesses and illegal pyramid schemes can be tricky, especially when the two do share quite a few similarities.
In the US, MLM companies are considered legitimate businesses that can sell products, go public, and enjoy tax benefits like all other companies. There is nothing that legally separates a legal multi-level marketing company from a normal business. There are no restrictions in promoting or marketing MLM companies publicly, either.
On the other hand, pyramid schemes are outlawed in the US. This form of business model is typically considered a chain distributor scheme or a Ponzi scheme. It uses high-pressure sales tactics to recruit new members to expand its sales network.
Currently, “pyramid scheme” is not the name of the federal crime itself. Instead, people engaging in such activity will usually be charged with related fraud charges for running these fraudulent schemes.
It can be difficult to tell the two apart, particularly since both programs have characteristics that aren’t common in mainstream business, such as having to pay a training fee or other up-front costs. Naturally, pyramid schemes will also try their best to look like legal MLMs, making them especially difficult to parse. Paying someone to be able to work makes little sense to many people, yet it can be a powerful way to keep recruits, who believe that since they have paid, they need to stick at it – the sunk cost fallacy.
Besides, both MLM programs and pyramid schemes often make extraordinary claims about making big bucks with the sales generated, leading to new members believing in the ease of earning money. The example below is from the Business in Motion pyramid scheme that collapsed in Canada in 2014, offering “Debt Free Independence”.
With so many similarities, you need to exercise a keen eye in spotting a legal MLM company from a questionable pyramid scheme. Before you start the recruitment process, it’s important to understand how each marketing strategy works and if you can benefit from participating in either of them. To further illustrate the difference between legitimate MLM programs and pyramid schemes, here are the key features to look out for.
What is a Pyramid Scheme? Recruitment Means Money
According to the State of California Department of Justice, an illegal pyramid scheme consists of several features with the most obvious warning sign being making money through recruiting other distributors.
In a pyramid scheme, promoters emphasize recruiting more members as the key to your business plan. The main business opportunities lie in the number of recruits you are able to bring to the business since new recruits all have to pay tremendous fees to join the company of which you get a cut.
This might sound nice, especially if you get in early, but a vast majority of people lose money on these schemes. Remember that the people you recruit to a pyramid scheme are also likely to lose money.
Even before your recruits begin selling products, you are entitled to some commissions. You are also entitled to more commissions when your recruits bring in others. The more people you bring in, the more money you can make, creating a pyramid structure with the top layers earning the most. Therefore, it can create unhealthy pressure to join the company immediately to not miss out.
A lot of the time, there may not even be actual products to sell since the focus is on recruitment, which is another warning sign that the company is not legit. Burn Lounge was ruled to be a pyramid scheme and on this poster you can see how the company encouraged people to bring others to their events.
Also, new distributors are often required to buy the products from the company first and resell them to their connections. Most distributors buy more products than they can resell, leading to financial problems for the members.
To sum up, here are the main characteristics of a pyramid scheme, according to the US Securities and Exchange Commission:
- Promoters play on your vulnerability and push you to join the company immediately.
- There are no genuine products or services sold by the business. For example, you may be asked to buy and resell cheap spa packages at unreasonably high prices.
- Recruitment is to be your main source of income rather than sales.
- You are given unreal promises about generating high returns within a short period of time.
What is an MLM? Sales is Key
Unlike a pyramid scheme, multi-level marketing does not pay existing distributors simply to recruit new team members. Its business opportunity lies in selling products.
To make money in a multi-level marketing company, not only do you have to sell the company’s products, but you may also have to train your teams of salespeople. You will only get paid a commission when your new recruits start making sales.
Since the MLM strategy primarily revolves around sales, these network marketing businesses will always have actual products or services to offer. Multi-level marketing differs from pyramid schemes in that MLM companies are running a legal business with credible products whereas, a pyramid scheme does not.
In a 2018 study completed by the AARP, they discovered that only about 25% of people break even from an MLM, compared to a 76.1% 1-year success rate for small businesses in the US, according to BLS data. Of those who were able to turn a profit, over half made $5,000 or less. Overall, one in 13 Americans had turned their hand to an MLM at some point in their working lives.
These direct sales companies emphasize person-to-person sales, encouraging members to sell products to their family and friends. This focus on promoting to people around you is often seen as exploitative and predatory, though not illegal.
In 2013, HuffPost investigated claims against Herbalife, a US multi-level marketing company that sells health supplements, that the business was involved in running a pyramid scheme. Herbalife can sometimes appear to be using pyramid scheme tactics rather than engaging in MLM activities. However, in 2015, a judge dismissed a lawsuit against the dietary supplement company over illegal pyramid scheme claims.
Then, just a year later in 2016, Herbalife entered a deal with the Federal Trade Commission to pay $200 million as a compensation plan to its customers who were led to believe they could earn money by selling herbal products. The company also agreed to restructure its multi-level marketing operation due to it closely leaning toward the pyramid scheme side.
The Herbalife case proves that there can be a murky line between an unlawful pyramid scheme and an unethical multi-level marketing operation, which is why a lot of network marketing firms tend to draw criticism.
Primerica is a publicly traded, leading insurance company in the US. Although for years it has denied being involved in either pyramid schemes or multi-level marketing, its structure resembles MLM.
For example, on its recruitment page, it states that employees are entitled to a commission based on their recruits’ sales. It also makes it clear that agents do not directly get a cut for recruiting others, which separates it from a pyramid scheme.
Overall, the job description does not contain extravagant promises, which is another common thing in pyramid schemes to overpromise. However, since its commissions are paid on multiple levels, it falls into a classic MLM strategy.
The same goes for another famous MLM business – Seint Makeup. It does not require any inventory fees from promoters like a pyramid scheme would. The company handles all product shipments and artists earn commissions through selling products and training their own teams. As their team expands, they will be entitled to more commissions, matching a textbook MLM structure.
| MLM | Pyramid Scheme | |
| Legality | Legal | Illegal |
| Commissions mostly based on | Sales | Recruitment |
| Products/services | Offer actual products/services | No real products/services |
| Inventory fees | No | Yes |
Examples of MLMs and Pyramid Schemes
After dissecting the core features and differences between legal MLM companies and illegal pyramid schemes, it’s time to take a look at the examples and consequences businesses have faced for operating in this domain.
It’s important to note that multi-level marketing is not intrinsically bad in nature. It can be an effective business model to grow your operations. However, due to its similarities with the pyramid scheme model and MLM programs can easily fallnto the legal grey area, you need to exercise caution when choosing the right business opportunity.
- Business In Motion International
The Canadian company was accused of running a pyramid scheme and ordered to pay $6.5 million to its 2,000 investors in a 2014 court ruling. Business In Motion International required early investors to pay CA$3,200 to purchase vacation packages to resell them at higher prices. Investors were also forced to recruit new members in order to keep themselves in the program. This is a clear example of a legally adjudicated pyramid scheme, based on its high initial investment and minimal product to sell. - Seint Makeup
Although Seint Makeup is proven to be running a legitimate business and is not associated with any pyramid scheme, its MLM structure continues to raise concerns from consumers. To this day, Seint Makeup continues to run its MLM model and has never been involved in any lawsuit for its business model. The structure of an artist recruiting and training their team and being encouraged to reach out to the network to make sales are markers that it is a multi-level marketing model. - Nu Skin
The American beauty brand adopts an MLM structure in its operation, though it has been called out for leaning towards the pyramid scheme side. In 2016, Nu Skin had to pay $47 million in a class-action lawsuit in China for running an illegal pyramid scheme and reached a settlement with the Michigan Attorney General in the 1990s after it brought action.
These examples demonstrate how MLMs and pyramid schemes can share a striking resemblance. Unethical businesses can mask illegal activities with a legal MLM front. Therefore, learning about the key features between them will significantly reduce your chance of investing in the wrong company and save you from possible legal hassles -or choosing a harmful or even prohibited business model.
Pyramid Schemes and MLMs – Are They Safe?
Pyramid schemes are 100% illegal in the US as well as most parts of the world. They are an unethical way of doing business that will never be sustainable. You should avoid committing yourself to a pyramid scheme or considering it as a growth tactic.
Be aware of the major red flags discussed in the article to spot sketchy business opportunities and avoid plunging yourself into debt and bringing others into a dangerous practice.
The HuffPost found in 2013 that even though Herbalife claimed an initial joining fee of just $59, most people ended up paying around $4,000 before they could start making money.
To keep the business going, distributors had to invest in the company constantly. Around 90% of salespeople quit within a year of joining Herbalife. On average, people lost $3,000 just by “working” for the company with some even losing $10,000. This is a typical, scammy pyramid scheme-adjacent operation that will leave you indebted, even if it isn’t technically illegal.
On the other hand, MLMs are often more controversial since they are legal, federally speaking, but considered highly immoral. Despite the two operational models being different, quite a few MLM companies have gotten into legal trouble for shifting their MLM businesses to pyramid scheme-like programs.
As a morally conscious entrepreneur, you need to understand your consumer expectations and the driving forces behind sustainable growth to formulate the most suitable investment strategies. Use this guide to distinguish between MLM vs pyramid scheme structures to help you avoid making mistakes and engaging yourself in questionable acts that can damage your public reputation and lead to legal charges.