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Businesses that sells products to family and friends and recruiting other people to do the same are called multi-level marketing (MLM), network marketing, or direct marketing businesses.

Multi-level marketing (MLM), also known as direct marketing or network marketing, is a method of selling products directly to consumers using independent sales representatives.

MLM companies mostly entice new recruits with promises of wealth and independence. While not legal by introduction, many MLMs have become unpopular for their controversial business practices—and others have been said to be less more than illegal pyramid schemes.

What Are MLMs and How Do They Work?

MLM companies distribute their products or services through person-to-person sales. That means you’re selling one on one to other people, maybe from your home, a customer’s home, or online.

If you register a MLM program, the company may refer you as an independent “distributor,” “participant,” or “contractor.” Most MLMs say you can invest into two ways:

• by selling the MLM’s products yourself to “retail” customers who are not part of the MLM.
• by training new distributors and earning commissions based on what they purchase and their sales to retail customers

Your distributors, the people they recruit, and so on, become your sales network or “downline.” If the MLM is not a pyramid scheme, it will pay you depending on your sales to retail customers, without having to recruit or train new distributors.

Most people who join legitimate MLMs make little or no money. Some of them lose money. In some instances, people believe they’ve joined a legitimate MLM, but it changes to be an unlawful pyramid scheme that illegally takes everything they invest and leaves them deeply in debt.

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What’s a Pyramid Scheme and How Do You Identify One?

Pyramid schemes are scams or false. They can seem to remarkably like legitimate or legal MLM business chances and regularly sell actual products, maybe even ones you've heard of. But if you become a distributor for a pyramid scheme, it can cost you and your recruits or newbies — often your family and friends — a lot of time and money that you won’t recover.

The marketers of a pyramid scheme may try to train you with tips about what you’ll earn. They may inform you can change your life — resign your job and even get rich — by selling the company’s products. That’s a lie. Your income would be based mostly on how many people you recruit or train, not the volume of product you sell. Pyramid schemes are established to encourage everyone to keep training people to keep a steady stream of new distributors — and their money — flowing into the business.

Regularly in a pyramid scheme, you’ll be encouraged or even required to purchase a certain volume of product at regular timeframes, even if you already have more stock than you can use or sell.

You may even have to buy products before you’re qualified to be paid or get certain bonuses. You also may have to pay repeated fees for other items, like recruiting sessions or expensive marketing materials. In addition, the company may say you can get lavish rewards, like prizes, bonuses, exotic vacations, and luxury cars. However, it often chnages that you have to meet specific product purchase, recruitment, training, or other goals to qualify for the rewards, and only a rare number of distributors ever qualify.

Eventually, most sellers discover that no matter how tirelessly they work, they can’t sell enough stock or recruit or train enough people to make money. They also can’t withstand required fees or the stock purchases they need to make to qualify for rewards, and they can’t earn enough money to meet their expenses. In the end, most people turns bankrupt, have to leave, and lose everything they invested.

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Here are some warning signs of a pyramid scheme:

1. Promoters make unusual promises about your earning capability. Stop. These promises are vague.
2. Promoters stresses on recruiting new distributors for your sales network as the real way to invest. Leave. In a legitimate MLM program, you should be able to invest just by selling the product.
3. Promoters takes advantage of your emotions or use pressurizing sales methods, maybe saying you’ll lose the chance if you don’t act immediately and discouraging you from taking time to learn about the company. Leave by the nearest exit. Any company that tries to stresses on you to join is one to run away.
4. Distributors buy more products than they want to use or can resell, just to stay active in the company or to qualify for bonuses or other rewards. If you see this happening, keep your money.

Is an MLM Right for You?

If you’re considering joining an MLM, know that some MLMs — even ones that aren’t pyramid schemes — may not be a wise investment. Other MLMs may not be a good fit for your interests and lifestyle. Here are some ways to help protect yourself against a bad MLM experience.

Ask yourself these quizzes

• Do you want to be a distributor? If you join an MLM, you’ll be a salesperson. Your job will be to distribute the company’s product and, in many instances, to force other people to join, invest, and start selling. If you don’t like selling, or if you’re stressed asking people you know to spend their time and money into a business opportunity, joining an MLM is a worst idea.
• Do you have a solid inventory plan? Ask yourself if whether you have friends and family who will purchase your products from you oftenly? Analyze how you would find and maintain other daily clients. Can people purchase similar products elsewhere, maybe at a cheaper price?
• What are your income goals or objectives? You might think that, with your willingness to work hard, you can get huge income through the MLM. In fact, most people who join MLMs and work effortlessly make little or no money at all, and some of them becomes bankrupt.
• Can you afford to risk the money and time? Every business opportunity has risks or misfortunes. MLMs are no different. Even if the start-up capital seem low, additional expenses can sum up quickly. Expenses can constitute of training and travel costs, website fees, marketing materials, costs to host parties, and costs to purchase products. If you are forced to borrow money or use your credit card to finance your costs, you may face huge interest charges too. Also, consider the time factors demands of the business, like attending to recruitment, training new distributors, managing paperwork, keying in inventory, and shipping products.

Pyramid Scheme vs. MLM

It’s known if the dynamic of MLM companies has you doubting if they’re little more than pyramid schemes. Both, after all, work with the same pyramid-shaped architecture.

So what results to one legitimate and the other an illegal scam? It draws down to the sales versus recruitment focus in the refund plan.

According to the Federal Trade Commission (FTC), “if an MLM is not a pyramid scheme, it will pay you based on your sales to retail customers, without having to recruit new distributors.” Pyramid schemes, meanwhile, rely on continuous recruitment of dues-paying members to stay afloat, even if they require members to keep on buying products that they may not be able to sell.

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MLMs and the 70% Rule

For an MLM to be compliant (i.e., legal and not a pyramid scheme), it must follow the 70% rule that “at least 70% of all goods sold must be ordered by non-distributors.”

That means buyers outside the company need to be purchasing the majority of a company’s products—rather than downstream in the distributor network or with the distributors themselves stocking up on inventory. But it’s incredibly hard to prove if an MLM isn’t in compliance, note Alemany and Cory Rusin, a researcher who works closely with former multi-level marketing distributors after they leave direct sales.

“It’s almost impossible to track if a distributor has stashed unsold products in their garage or closet,” says Alemany. “For the most part, MLMs take their distributors at their word.”

And even if a distributor were clearing 70% of their inventory in a given month, the “financial freedom” offered by many MLMs simply cannot be achieved through direct sales alone, says Rusin.

“When you analyze the compensation plans of MLMs, the real money is made through recruitment,” she says.

Do your homework

• Research the company. Search online for the name of the company and words like “review,” “scam,” or “complaint.” You may also want to look for articles about the company in newspapers, magazines, or online. Does the company have a good reputation for customer satisfaction? Check with your state attorney general for complaints. A lack of complaints doesn’t guarantee that a company is legitimate, but complaints can alert you to possible problems.
• Research what distributors are saying. Individual distributors often post their own training videos online to promote the MLM. Search for these materials. Be suspicious if the trainings make earnings claims, tell you that the fastest way to make money is to “recruit, recruit, recruit,” or suggest that all you need to do to build a downline is “find two people who find two people.” Claims like these are hallmarks of a pyramid scheme.
• Consider the products. MLM companies may sell quality items at competitive prices. But some offer goods that are overpriced, have questionable benefits, or are downright unsafe to use. For example, be very skeptical about health products advertised as having “miracle” ingredients or guaranteed results. Those claims are generally false or at least unproven and, at worst, the products could be dangerous.
• Understand the costs. Many MLMs make you buy training or marketing materials, or pay for seminars on building your business. You may need to book travel and pay for hotels and meals. Make sure you know what you must pay for, and how much it will cost over time. If the company says some of these things — like periodic product purchases or training — are optional, find out if you’ll become ineligible for bonuses or rewards if you opt out of them.
• Ask about refunds. In many MLMs, before you can start selling the products, you have to buy them from the company. So get the company’s refund policy in writing. Make sure it includes information about returning any unused products, including restrictions and penalties. Consider whether you’ll get a full refund or only a partial one — and how long it may take.
• Read the paperwork and have a friend or advisor review it. Read the company’s sales literature, business plan, disclosure documents, and any contracts or agreements you’ll need to sign. Ask an accountant, a lawyer, or someone else you trust — and who is not affiliated with the company — to help you review the MLM’s materials. Ask them to look at your possible earnings and whether the company can back up its claims about how much money you can make. Ask for their honest opinion about whether they think the MLM is legitimate and a good fit for you.

Talk with current and past distributors about their experience in the MLM

Ask tough questions and seek for details. Don’t assume it nosy or intrusive. You’re thinking about starting a small business. A good businessperson needs those answers. Here are some questions to ask:

• How long have you been in the MLM?
• How much money did you make last year, after expenses?
• What were your expenses last year?
• Have you borrowed money or used your credit card to fund your business? How much did you borrow? How much do you owe?
• Do you need to have recruits to make money?
• How many people have you recruited? How many did you recruit last year?
• How many of your recruits or trainees have left the business?
• What percentage of the money you made came from distributing the product to customers outside the MLM?
• What percentage of the money you made — income and bonuses less your expenses — came from recruiting other salespersons and selling them stock or other items to get started?
• How much time do you spend on the business?
• How much stock did you buy from the MLM last year? Did you distribute all of your inventory?

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Conclusion

Remember, you’re on a journey to check out a potential business deal that will require your time and money. The information you grasp can help you make an informed decision whether it’s really a deal, or straight up unlawful.

Credits: Forbes, Consumer Advice & Ramsey