Last Updated on February 27, 2022 by Matt Zavadil
Let’s look at the pyramid scheme definition.
By the way, pyramid schemes are illegal in the United States and many other countries.
However, that doesn’t stop people from trying to start them.
In this article, I’ll discuss what a pyramid scheme is and how to recognize one.
I’ll also provide some tips on how to avoid being scammed by these types of schemes.
What Is a Pyramid Scheme?
A pyramid scheme is a business model that relies on recruiting new members to make money.
The people at the top of the pyramid earn the most money, while the people at the bottom earn very little or nothing.
Pyramid schemes are illegal, and they can be very dangerous to participate in.
How to Recognize a Pyramid Scheme
There are several ways to recognize a pyramid scheme.
One of the most obvious is if someone is trying to sell you a business opportunity where you often pay a large sum of money upfront.
They may also promise you high returns with very little risk.
Be wary of any business that asks you to invest a lot of money without knowing anything about the company or the product.
Another way to recognize a pyramid scheme is if no product or service is being offered.
Pyramids are based on the idea of recruiting new people, not selling a product.
If someone is trying to sell you a business opportunity and no product or service is being offered, it’s probably a pyramid scheme.
Oh, THAT’s Why MLM is NOT an Illegal Pyramid Scheme
By the way, this is why most network marketing companies are NOT illegal pyramids.
When’s the last time you were recruited into an MLM that didn’t rave about its product?
When’s the last time you were paid to get someone to sign their John Hancock as your next MLM recruit?
Ahhhh…makes sense now, huh?
The MLM model is just fine.
History of Pyramid Schemes
Pyramids have been around for centuries.
The first pyramid scheme was created in 1798 by a man named Charles Ponzi.
Ponzi promised people that they could make a lot of money by investing in his company.
He was able to convince a lot of people to invest, and he made a lot of money.
However, he wasn’t actually making any money from his business.
He was just using the money that people were investing to pay them back their initial investment, plus a little bit extra.
Eventually, Ponzi’s scheme collapsed, and he was arrested.
Since then, pyramid schemes have become more sophisticated.
They’re often run by people who are very good at lying and manipulating people.
What’s a Ponzi Scheme?
Although Charles Ponzi discussed his company, rather than a business operation, these schemes typically talk more about investments…
…as opposed to getting you into something where you do work.
A Ponzi scheme is a type of pyramid scheme where people are promised high returns on their investment. The money that’s being earned by the people at the top is coming from the investments of the people at the bottom.
If the people running the Ponzi scheme can’t get new people to invest, they don’t have any money to pay the people already in who are expecting their next payment.
Why Do People Get Caught Up in Pyramid Schemes?
Many people get caught up in pyramids because they’re tempted by the idea of making a lot of money with very little risk.
Pyramid schemes are also very addictive. Once someone gets involved in a pyramid, it’s often hard for them to stop. They may keep investing more and more money, even when they can’t afford it.
These schemes often prey on people who are vulnerable, such as those who are unemployed or underemployed. People who are struggling financially are often desperate for a way to make quick money.
Example of a Pyramid Scheme
One of the most recent and well-publicized pyramids was run by a man named Bernard Madoff.
Madoff ran an investment company, and he promised his clients that they could earn high returns with very little risk.
Many people invested their life savings with Madoff, only to lose everything when his pyramid scheme collapsed.
How Can You Spot a Pyramid Scheme?
One of the easiest ways is to look at how the business is structured. A legitimate business will have products or services that it sells to customers. A pyramid scheme, on the other hand, will focus on recruiting new people.
Any business that offers a product for sale is most likely just fine.
A problem exists if you get paid for getting me to sign recruitment papers, or if you take my money to put into an intangible “investment” without much disclosure.
Again, this is why the average Joe out there telling you that network marketing, direct sales, or MLM companies are “pyramid schemes” is severely misinformed.
How Do I Get Out of a Pyramid Scheme?
If you’re already involved in a pyramid scheme, it can be very difficult to get out.
The first step is to admit that you’ve been scammed. This can be hard to do, especially if you’ve invested a lot of money into the scheme.
Once you realize that you’ve been scammed, you need to cut off all contact with the people who are running the pyramid.
Finally, you need to get your money back. This is often very difficult, and it may not be possible.
What Is a Legitimate MLM Business?
A legitimate MLM business will have products or services that it sells to customers. The focus will not be on recruiting new people, but rather on selling products or services.
However, there’s absolutely nothing wrong with the act of recruiting new people into your network marketing downline.
Remember, you can’t make money unless those people go make retail sales themselves.
See how that’s not a pyramid scheme?
The product gets moved and the recruiter simply gets a piece of the commission generated by selling a product to a consumer.
It’s similar to an insurance or real estate brokerage.
The broker doesn’t make any money until the insurance policy is sold, or the home is bought.
FAQs About Multi-Level Marketing & Pyramid Schemes
Hopefully, it all makes sense now. Selling a product? You’re probably good to go. No product to sell? Problem.
Let’s review more commonly asked questions about pyramids, multi-level marketing, and whether it’s OK to be a part of a legitimate multilevel marketing plan where you bring in new recruits.
What is a pyramid scheme exactly?
A pyramid is a business model that relies on recruiting new people to make money. The person at the top of the pyramid makes the most money, and the people at the bottom make very little or no money.
Doesn’t that describe MLM?
No, it’s the exact opposite. Legitimate MLM companies sell legitimate products through a direct sales force. In all actuality, there’s no one “at the top” making all the money. Anyone thinking that reveals a severe misunderstanding about the MLM business model.
Why aren’t only the people “at the top” making “all the money” in MLM?
Because if you recruit me into your legitimate multi-level marketing company, I can outsell and out recruit you and pocket more income than you do. You’ll make some money from my sales and my team’s sales. However, in most MLM companies, the comp plan doesn’t reward your inability to perform as well as I know how to do.
That’s the exact opposite of illegal pyramid schemes where you get me in and I can’t do anything about my situation after getting “scammed”.
Can you go to jail for being in a pyramid scheme?
Are you the evil mastermind with pinkie cocked at the lip like Madoff? You betcha. Off to jail, you go. But, if you’re mistaking a legitimate MLM company for a pointy pyramid, where a real product is being sold and you can also get into recruiting members to sell with you, then no one’s going to jail.
Does the FTC regulate MLMs?
The Federal Trade Commission is the government entity that regulates pyramid schemes, Ponzi schemes, and multi-level marketing companies in the United States. MLM companies have to follow certain Federal Trade Commission guidelines. The most important guideline is that they must sell a real product or service.
Final Thoughts On Pyramid Scheme Definition
As you can now see, a pyramid scheme entails a situation where you get paid to keep bringing new people into an organization without real business activities.
It typically revolves around an investment scheme, where you can’t find financial statements to prove the investment’s worth. New investors must keep coming in to pay earlier investors.
This pyramid structure is an unsustainable business model. After some time, the pyramid collapses.
Typically, your only hope is that the Better Business Bureau and FTC find out about such schemes and come to save you on a white horse. Unfortunately, that probably doesn’t happen and you’ll need to simply move on after the scheme collapses.
Finally, 99.999% of multilevel marketing companies don’t fit the definition of a pyramid scheme.