Five Ways to Know a Pyramid Scheme

Posted by CapWay in Opportunities & ResourcesNovember 17, 2022(Last Updated November 18, 2022)5 min read
Key Takeaways
  • Some companies follow an illegal business model of luring people in and taking their money.
  • Corporations that follow unlawful business models are known as pyramid schemes and typically make false claims about “getting rich quickly” to the financially vulnerable.
  • The Securities and Exchange Commission discusses certain distinguishing features of a pyramid scheme to look out for and avoid.
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Millions of people search the internet for a new job or ways to make extra income. Companies can lure people in with job postings that often sound too good to be true. Some companies promote positions where the employees can make substantial money in exchange for doing little work. If you happen to have crossed paths with any advertisements that feel more like a recruiting effort, then it may have been the product of a pyramid scheme.  

 

Definition of a Pyramid Scheme

 

One standard business model that some companies choose to follow is “Multi-Level Marketing” (MLM). A legitimate MLM company focuses on finding new distributors to sell its products, and its employees are compensated based on their sales levels. However, an illicit version of this ideology has corrupted the market. A pyramid scheme is when people are tricked into thinking they are working for a legitimate MLM business, resulting in them getting scammed and losing their money. 

 

How a Pyramid Scheme Works

 

Pyramid schemes target specific individuals by falsely advertising signs of high returns in a short time period. Pyramid schemes lure people in through social media and advertisements on various websites. The promoted messages seem legitimate at first glance and will display advertisements about how the people who joined the company are making a significant amount of money. 

 

People often pursue higher-paying opportunities for various reasons, like wanting to achieve financial freedom faster. So, these marketing messages lure and intrigue most people into joining a company. After becoming interested, the pyramid scheme begins its pitch, making promises of high returns in a short time period and how their plan will make them money simply by recruiting people and selling a product.

 

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As a result of the pyramid scheme following a similar business model to an MLM corporation, a number of people, unfortunately, fall for this elaborate scam. Since no one wants to lose time or money on a fraudulent business model, the Securities and Exchange Commission (SEC) highlighted the key ways to know a pyramid scheme. 


Key Factors to Know About a Pyramid Scheme

 

Recruiting, Not Selling

 

The telltale sign of a shady business is that you don’t make much money from selling the products or services. Typically, sales positions are commission based, meaning a person is paid based on generated revenue from retail sales. However, if the company makes you recruit new participants instead of selling a product, then do not pursue this position. More likely than not, this is a pyramid scheme, and you get paid by getting more people to join the business. 


No Actual Item is Sold


Another way to spot a pyramid scheme is if no genuine product or service is sold. Some pyramid schemes focus on making the person invest in purchasing high-level products which will sell quicker. These items will not help you make sales. Instead, you will be left with a bunch of worthless inventory, and the pyramid scheme scams your money.  

 

Promises of High Returns in a Short Period

 

Many predatory companies specialize in making big promises about the amount of money you can make. When entering a new business venture, it is best to be as cautious as possible. If the amount of money they say you will be making seems odd, then do more research before making any decisions.


A Buy-In is Required

 

person entering card info

Image Credit: Ivan Kruk / Shutterstock.com

 

One common factor of an illegal pyramid scheme is that you must “invest” in the company. Instead of the company giving you the resources you need to make them money, they encourage you to “invest” in the tools that you will need or to give a general “investment” before getting started.

 

Recommended Read: How to Read Financial Statements | Investing for Beginners

 

Typically, these “buy-ins” are phrased as either a one-time-only purchase or a recurring monthly subscription. These expenses are marketed as minimal compared to the money that you will make. In reality, the pyramid scheme is profiting off you by tricking you into buying items that will not benefit you.

 

Uniformed Pay Structure

 

A legitimate MLM company will have a compensation formula that clearly explains the varying factors in your income, such as bonuses, sales, and commissions. However, for a pyramid scheme, they use a more complicated formula to throw people off about how they will get paid. Therefore, a rule of thumb is to be cautious if you need help determining what factors supplement your income.


Difference Between Illegal Pyramid Schemes and MLM Companies

 

People think the terms “Pyramid Scheme” and “Multi-Level Marketing” are interchangeable. But now that the major indicators of pyramid schemes have been covered, it is essential to know how to distinguish a pyramid scheme from a legitimate MLM company. The major difference is that an MLM company has legitimate products or services being sold. 


According to the Federal Trade Commission (FTC), an MLM company will pay you based on your sales levels, and they will NOT make you recruit new distributors. On the other hand, a pyramid scheme focuses on finding new members and encouraging you to purchase more of their products. 


Therefore, if you think that you part of a pyramid scheme, ask them about the pay structure. If the money you receive depends on your sales, the possibility of the company being a legitimate MLM is higher. On the other hand, if they say it is based on recruiting members, then there is a possibility that you are getting involved in a pyramid scheme. 


How to Prevent Getting Scammed

 

pyramid scheme

Image Credit: kenary820 / Shutterstock.com

 

To prevent falling victim to a pyramid scheme, research the company before pursuing a job opportunity. Typically, pyramid schemes will have information that does not add up. Therefore, if you find yourself in a situation where the information about the company seems odd, cut ties with them immediately, as it is better to be safe than sorry. 

 

Before applying to any job posting on the Internet or in person, do your research about the company beforehand. Here are three ways you can vet a company:  

 

  1. Talk with your network. Ask family and friends if they have ever heard of such a company. 
  2. Read online reviews. In addition to reading online reviews about the company, also read news articles about the company. 
  3. Talk with current and former employees. A simple conversation can give you a better gauge of how a company runs its business and treats its employees.

 

The Money Wrap-Up


Many people have a common misconception that they can make a comfortable living simply by signing up for one of these companies and “getting rich quick.” In reality, living comfortably takes years of dedication and hard work. Instead of trying to make easy money by doing little work, try to find ways to increase your income over time. There are many side hustles that can help you to have multiple income streams.

 

Main Image Credit: rudall30 / Shutterstock.com

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