Moneyadviceblog » Investment » How Not To Fall For Pyramid Schemes And Other Scams

In recent years many companies have successfully utilized so-called “multi-level marketing” practices. It is important, therefore, to address the differences between a pyramid scheme and a legitimate multi-level marketing company.

What Is A Pyramid Scheme?

A pyramid scheme is a fraudulent system of making money based on recruiting an ever-increasing number of “investors.” The initial promoters recruit investors, who in turn recruit more investors, and so on. The scheme is called a “pyramid” because at each level, the number of investors increases. The small group of initial promoters at the top requires a large base of later investors to support the scheme by providing profits to the earlier investors.

Pyramid schemes may or may not involve the sale of products or distributorships. The trend is to involve sales of products or distributorships in an attempt to show legitimacy. This is done solely to sidestep the regulatory agencies, as most state laws prohibit marketing practices where the potential for profit stems primarily from recruiting other investors and not from the sale of products. The bottom line, however, is that in all pyramid schemes, the selling of a product itself is much less important than the recruiting of new investors.

What Is Multi-Level Marketing?

Multi-level marketing is a method of selling products directly to consumers without intermediary retail stores. Products are sold through a network of distributors or salespersons set up to resemble a pyramid: each distributor recruits and trains additional distributors and will earn commissions on their sales, as well as on the sales he or she makes. Because of their pyramidal structure, multi-level marketing companies can sometimes be pyramid schemes.


What Are The Differences Between A Legitimate Multi-Level Marketing Company And A Pyramid Scheme?

A legitimate multi-level marketing company emphasizes reliable products or services. A pyramid scheme uses products or services to disguise its quest for collecting money from the investors on the bottom levels to pay other investors further up the pyramid.

In a typical pyramid scheme, new investors must pay a fee for the right to sell the products or services as well as for the right to recruit others into the pyramid for rewards unrelated to product sales or services. Very often the products or services the victim must buy are unsalable, and the pyramid’s promoters refuse to repurchase them. On the other hand, legitimate multi-level marketing companies will buy back unsold merchandise, although often at a discount from the original price.

Success in multi-level marketing is based on two factors: product and service quality, and the hard work involved in being able to sell the products or services. Recruitment of new investors is secondary.

Why Do People Invest In Pyramid Schemes?

If all pyramid schemes fail, why would anyone invest in them? There are three basic categories of people who invest in pyramid schemes: those who participate out of greed; those who are misled into thinking that they are joining an “investment club” or a “gift program”; and those who believe that the products or services are legitimate.

How Can You Avoid Being Defrauded?

The easiest way to avoid being defrauded is obviously not to participate in any promotion that appears to be a pyramid scheme. The following are some additional tips to help you steer clear of pyramid schemes:

Gather all information regarding the company, its officers, and its products or services. Get written copies of the company’s marketing plan, sales literature, contracts, etc. Avoid promoters who fail to explain their plans clearly and in detail. In particular, read the company’s prospectus or other written material. (A prospectus is a legal document that gives prospective investors information about a company.) If you don’t understand it, get someone independent of the company to explain it to you.

Find out if there is a demand for the product or service. Is there a similar product or service on the market? If so, how well does it sell? If the promoters seem to be making most of their money by selling distributorships or large start-up inventories to new recruits, stay away.

Ask if you must buy a product to become a distributor. Find out if the company will buy back your inventory –you could get stuck with unsold products. Legitimate companies will buy back inventory for at least 80 to 90 percent of what you paid. Get all promises in writing.

Beware if the start-up cost is substantial. Some pyramid schemes pressure you to pay a large amount to become a “distributor.” What are you getting for your money? Beware of promises of quick, easy and unreasonably high profits.


If the distributorship is providing a product for use to make a final product, make sure that whatever you provide reaches the final manufacturer. If you can, call or visit the manufacturer and ask for a list of its customers. Call the customers and ask if they are satisfied with the product.

Resist the temptation to invest just because the people selling you the program are friends or are part of your religious or social organization. They may have been misled into believing that they could make large amounts of money in a short time.

The Bottom Line

In some cases, an MLM program may be a source of supplemental income. Unfortunately, however, a lot of MLM participants don’t make a profit. Furthermore, MLM participants can fall victim to scams in the form of pyramid schemes. These illegal schemes are extremely risky and frequently leave you with less money than you had before. Before signing up for an MLM program, be sure to do your homework so you can avoid becoming yet another casualty of fraudsters.