Around 10% of the American workforce is self-employed. Nearly two-thirds of the rest of the workforce would prefer to own their own business. If you count yourself among those with entrepreneurial dreams, you should be careful when considering what business opportunities come your way. Although many are legitimate, many others are nothing more than elaborate scams.
One type of scam that has defrauded countless Americans over the past several decades is the pyramid scheme. A pyramid scheme may be structured to look like a real business, but it is actually just a vehicle for transferring money from new recruits to those who joined before. As you consider starting your own home-based business, you should keep a critical eye out for the signs of a pyramid scheme.
Article at a Glance
- A pyramid scheme is a fraudulent business structure where you pay to join and earn money by recruiting others, not by selling a product or service.
- Pyramid schemes are illegal, because they inevitably collapse, leaving the most recent recruits holding the bag.
- You must be careful in assessing business opportunities to avoid getting pulled into a pyramid scheme. Ask: What am I paying for? How will I make my money?
What is a Pyramid Scheme?
The fundamental feature of a pyramid scheme is that you pay join it, and then you receive payments out of the scheme mostly as the result of recruiting new participants. The problem with pyramid schemes is that they ultimately go bust. At some point, nobody else wants to join, and the last people to be recruited never get their payout. People who fall prey to pyramid schemes are often just trying to make ends meet, but end up losing their whole “investment.”
Pyramid schemes are illegal in California under state and federal law. The California Penal Code calls pyramid schemes “endless chain schemes,” and running one is a crime. The Penal Code defines “endless chain scheme” as:
any scheme for the disposal or distribution of property whereby a participant pays . . . for the chance to receive compensation for introducing . . . additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant.
That may sound confusing, but it means that if you have to pay to participate in a program and then make money by recruiting others, you’re involved in an “endless chain scheme” or pyramid scheme.
At the federal level, pyramid schemes are illegal under the Federal Trade Commission Act. The Federal Trade Commission (FTC) characterizes a pyramid scheme as one in which participants pay money to a company in exchange for:
- The right to sell a product; and
- The right to receive rewards unrelated to the sale of product to ultimate users whenever the participants recruit new participants into the program.
(For a deeper look at pyramid schemes and the FTC, check out this speech by the agency’s former general counsel.)
Recognizing Pyramid Schemes
People who run pyramid schemes don’t want you or their other participants to know they’re running a pyramid scheme. So, they’ll often try to hide the nature of their program using clever semantic tricks. They might refer to their scheme as a multi-level marketing program (about which, more in a moment), a gifting program, dinner party, “airplane game,” or something equally innocuous.
And, as the FTC’s definition suggests, many pyramid schemes try to dress themselves up as legitimate sales-oriented businesses by having some product for recruits to sell—or attempt to, at least. Most of the time, these products are in low demand, and most people make very little (or nothing) from sales.
But all pyramid schemes have a similar bottom line: Most or all of the money comes from recent recruits paying to join, not from the sale of a product.
So what are some practical tips for recognizing a pyramid scheme as you consider different work-from-home options? You should ask yourself two questions:
- What am I paying for? Are you paying to join the program or to purchase inventory? If you’re buying inventory, is it something people might actually want to buy?
- How will I make my money? Will you actually make your money from commissions when you sell the inventory you purchased? Or will most of your money come from recruiting others? How does the person who introduced you to the program make his or her money?
When in doubt, remember the old adage: If something seems too good to be true, it probably is.
Similar Business Structures
One way to learn how to recognize pyramid schemes is to understand how they differ from some legitimate business structures that may seem superficially similar, such as multi-level marketing, franchises, and retailer affiliate programs.
Multi-level marketing (MLM) can be a legitimate marketing structure for businesses to use. In an MLM business, you sell a product and recruit other sellers. Then, you receive commissions on your sales and on the sales of the people you recruited as sellers. The key difference is the focus of the program: Are rewards tied to recruitment or actual sales to end users? Which does the company emphasize?
CAUTION: There is a fine line between a legitimate MLM structure and a pyramid scheme. Some pyramid schemes include merchandise that can be bought by participants and sold to others. But if the focus of the program and its rewards is on recruitment, it’s likely a pyramid scheme.
In a franchise, you pay for the right to start a business using the business name, logos, trademarks, and other trappings of an established company. Think McDonald’s or Subway, although more than just restaurants are franchised. You make your money from sales to customers, not by recruiting others to buy their own franchise.
In the Internet age, another type of marketing has become popular: using affiliate links. Affiliate links appear in blog posts, news stories, and YouTube videos. When you post an affiliate link to a retailer (like Amazon), you get a small share of any money spent by users who access that retailer’s website through your link.
In general, affiliate links are completely legal (although still subject to regulation). The people who use your link are not paying for the chance to participate in the affiliate linking program, but to buy some product or service. And your compensation is tied to those sales.
Be Smart When Working from Home
Half of all new businesses in the United States fail within the first five years. That means that even with a good idea and a legitimate business, your odds of lasting success are still only 50/50. If you aren’t careful in screening the business opportunities that come to you, the odds are even worse.
Recognizing the warning signs of common scams and fraudulent work-from-home opportunities is a critical first step in building a successful home-based business to supplement your income. By understanding what a pyramid scheme is and how to identify one in the real world, you can reduce your chances of being defrauded out of hundreds or thousands of dollars as you seek to start your own home-based business.
One final note: If you are struggling with debt, you don’t have to spend your time, energy, and money sifting through get-rich-quick schemes or work-from-home scams to find a legitimate option. Bankruptcy can give you a fresh start financially, making it easier for you to live on what you currently earn. If you’re interested in learning more about how bankruptcy can reduce financial strains on you and your family, contact the experienced bankruptcy lawyers of Borowitz & Clark.