Money doesn’t come from nothing, unfortunately. It doesn’t matter if it’s called an “investment,” if it sounds too good to be true, it probably is. If you are pitched with an investment offer making the same promises, it’s probably a pyramid scheme.
Companies nowadays employ multilevel marketing techniques. To spot shady marketing from the legitimate kind, you will first have to take off your rose-tinted glasses and accept that the world isn’t as wishy washy as you thought it to be when you were playing with toys.
To understand how pyramid schemes work and, more importantly, how to spot one, let’s first understand what the term actually means.
What Is a Pyramid Scheme?
Pyramid schemes are sketchy business models employed by fraudsters to attract investors with the promises of quick, exceptional returns. New members join after a few top-level members recruit them and pay them upfront fees and costs to become part of the team.
It is through the new joining members that more members get recruited. Every new participant in the pyramid pays up the fees which pays back the amount of paid by the recruiting member.
As a result of hiring, paying, and funneling of the funds up the pyramid, recruitment and payments continue until there are no more recruits joining.
Pyramid schemes collapse when they are unable to recruit new members or, another way of saying the same is, when they stop collecting more money.
The majority that joins later end up losing all their money.
How to Stay Away From a Pyramid Scheme?
The best way to steer clear of a pyramid scheme is to spot the investment for the fraud that it is. You need to have a trained eye in accounting or auditing to become adept at it.
Taking CFA or CPA programs to gather valuable insights will help you spot the potential pitfalls in an investment. CPAs have the most rigorous exams. To ensure you are well prepared for the test, you enroll with Wiley Efficient Learning where you can get access to live online classes. Make sure to check out Wiley CPA Review to ensure you are entering the right program for your study requirements.
Although charlatans of the financial world cannot fool the experts at the investment game, they find easy prey in the masses. They are unscrupulous in their exploitation and will swindle you out of every cent you have if they had it their way.
Let’s now contrast multi-level marketing with pyramid schemes. Multi-level marketing uses the same principles as a pyramid scheme. Let’s first understand what multi-level marketing is.
What Is Multi-Level Marketing?
Using multi-level marketing, products are sold directly to consumers without any intermediaries, such as retail stores.
Distribution is carried out by a network of distributors or salespersons in the form of a pyramid: distributors recruit and train additional distributors and earn commissions on their sales as well as their own.
Pyramid schemes are sometimes multi-level marketing companies due to their pyramidal structure.
Multi-Level Marketing Companies vs Pyramid Schemes: What Is the Difference?
Legitimate multi-level marketing companies sell reliable products and services. The shady marketing companies that into schemes use products or services to disguise their actual goal: collecting money from investors on the bottom levels to pay the investors above.
Most pyramid schemes require new investors to pay upfront fees to be able to sell products or services and to recruit others into the pyramid for rewards unrelated to product’s sales.
It is common for the victims to be forced to purchase unsalable products or services that the pyramid promoter will not repurchase. Multi-level marketing companies, on the other hand, usually offer a discount when they buy back unsold items.
Multilevel marketing success is determined by two factors: the quality of the product and service and your ability to sell it. New investor recruitment is secondary.
How to recognize a Pyramid Scheme?
The classic pyramid scheme involves participants making money solely through hiring new recruits.
In a pyramid scheme:
- Promoters promise high returns in a short time frame
- There is no genuine product or service to be sold
- Recruiting new participants is the primary focus
Investors lose most of their money in pyramid schemes when they inevitably collapse.
Pyramid schemes have the following characteristics:
- A strong emphasis is placed on recruiting. If a program only focuses on recruiting other people to join for a fee, it’s most often a pyramid scheme. Don’t be tempted to join and recruit others if you are promised more earnings than actual product sales.
- There is no genuine product or service to be sold. Be cautious if the business is selling products or services that are difficult to value, such as e-books with commercial licenses, ads on rarely visited websites, or so-called “tech” services. For example, some fraudsters use phony products to hide the fact that the company runs a pyramid scheme.
- High returns promised in a short period of time. Don’t be fooled by cash-in-a-day offers – they may be paying commissions to new recruits instead of product sales revenue.
- Income from passive sources or easy money. The golden rule is you get nothing for free. Having to make payments, recruit others, or place advertisements on obscure websites in exchange for compensation may be part of an illegal pyramid scheme.
- There is no evidence of retail sales revenue. Obtain documents showing that the company generates revenue by selling its products or services outside of the program, for example, an audited financial statement by a CPA. The primary source of revenue for legitimate MLM companies is product sales, not recruitment.
- Structure of commissions is complex. Unless commissions are based on products or services sold to people outside the program, you need not be concerned. Don’t accept compensation if you do not understand how it is calculated.
Pyramid schemes are often promoted through social media, internet advertising, company websites, group presentations, conference calls, and YouTube videos. The promoters of pyramid schemes often take great pains at disguising the scheme as a reputable multi-level marketing program. Early stage investors (usually recruits as well) are paid off by new recruits with money paid by new recruits. Once the scheme gathers momentum, it becomes impossible for the promoter to compensate earlier investors, and investors start losing money. It is a pyramid scheme when fraudsters try to make money solely by recruiting new members. Ultimately, all pyramid schemes collapse, and it’s just a question of when.