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How to Tell the Difference Between a Pyramid Scheme & a Legit Business

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Nearly one-third of U.S. workers describe themselves as “free agents,” and talk of the “gig economy” has grown so loud that it’s an issue in the presidential campaign. As more people look online for work that supplements —or replaces — their old-fashioned paycheck and helps pay down debts, it seems time for a reminder about popular work-at-home programs that might not be what they seem. When you’re looking for a “gig,” you want to know how to spot questionable “opportunities” – and you certainly don’t want to rope friends and family into them.

The Gig Economy Is Up

In an economic recovery that’s still dogged by fits and starts, it’s inevitable that workers will look to new sources of income. It’s hard to quantify the gig economy, but Kelly Services, a recruiting company, tried recently. It defined free agents as independent contractors, freelance business owners, temp workers, moonlighters and employees with multiple sources of revenue. By that definition, 31% of U.S. adults surveyed called themselves free agents. Meanwhile, Republican presidential candidate Jeb Bush extolled the virtues of the gig economy recently by taking an Uber ride and Democratic presidential candidate Hillary Clinton warned in a speech that gig workers might not have the legal protections they need.

“This on-demand, or so-called ‘gig,’ economy is creating exciting economies and unleashing innovation,” she said. “But it is also raising hard questions about workplace protections and what a good job will look like in the future.”

Among the protections workers need is security that when they interview for an online, work-at-home job, the position is real. A recent survey by FlexJobs, a job-search site, found that 17% of adults said they’d been scammed at least once while looking online for a job — meaning they’d been roped into criminal activity or were never paid for work they did.

Recruiting friends for sales jobs — and earning commission from your recruits’ sales — is among the more popular work-at-home gigs to be found online. The jobs can range from perfectly legitimate to legal, but a bit shady, to outright fraud. If you are entertaining work in this arena, it’s important to know how to spot trouble.

Pyramid Schemes vs. Multi-Level Marketing

The terms you’ll see most associated with this type of work are “multi-level marketing,” which is legal, and “pyramid scheme,” which is illegal. It might seem easy to distinguish between these two, but that’s not always the case.

In short, a legal multi-level marketing (MLM) firm must have a legitimate product, and derive real profits from that product. If a firm derives most revenue from recruits — using the new recruit money to pay older employees, for example — that’s a pyramid scheme. Common sense goes a long way here. If you’re going to be selling something virtual that has no intrinsic value — or talking friends into doing so — you are on thin legal and economic ground. Pyramid schemes always collapse, as the pool of new recruits eventually dries up.

Naturally, firms that run pyramid schemes will often try to convince recruits that they are, in fact, a legal multi-level marketing company. And since the firm’s very existence depends on doing so, many sales pitches you hear will be very aggressive and persuasive. So never rush into any arrangement with such a firm, particularly if there’s a large cost to buy into the program.

The SEC has a handy checklist of signs that you might be looking at a pyramid scheme:

No genuine product or service. MLM programs involve selling a genuine product or service to people who are not in the program. Exercise caution if there is no underlying product or service being sold to others, or if what is being sold is speculative or appears inappropriately priced.

Promises of high returns in a short time period. Be leery of pitches for exponential returns and “get rich quick” claims. High returns and fast cash in an MLM program may suggest that commissions are being paid out of money from new recruits rather than revenue generated by product sales.

Easy money or passive income. Be wary if you are offered compensation in exchange for little work such as making payments, recruiting others and placing advertisements.

No demonstrated revenue from retail salesAsk to see documents, such as financial statements audited by a certified public accountant (CPA), showing that the MLM company generates revenue from selling its products or services to people outside the program.

Buy-in required. The goal of an MLM program is to sell products. Be careful if you are required to pay a buy-in to participate in the program, even if the buy-in is a nominal one-time or recurring fee (e.g., $10 or $10/month).

Complex commission structure. Be concerned unless commissions are based on products or services that you or your recruits sell to people outside the program. If you do not understand how you will be compensated, be cautious.

Emphasis on recruiting. If a program primarily focuses on recruiting others to join the program for a fee, it is likely a pyramid scheme. Be skeptical if you will receive more compensation for recruiting others than for product sales.

Deciding the Gig Is a Good Fit

Even if a firm you are considering passes the pyramid test, that doesn’t mean you should get involved. “Legal” doesn’t necessarily mean it’s a good idea. Some perfectly legal MLMs may be a bad idea for you. For starters, these jobs in the end are sales jobs, and in many cases, something akin to door-to-door sales. You’ll make money by doing the hard job of convincing people to buy a product. You might make additional money by convincing friends and family to also sell that product, but you might also lose friends and family that way. And, in the end, you’ll be relying on their sales abilities, too.

Even with an MLM, it’s important that you believe you can earn decent money for bills, like a mortgage or car payment, simply from selling the product yourself. If the real money that has your attention comes only from recruitment — your “downline” in industry lingo — you are likely to be disappointed. The field of friends you can recruit shrinks very fast.

Most of all, if you wouldn’t buy the product yourself, then you probably shouldn’t try selling it.

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