MLM or pyramid scheme? Look out for these red flags

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It’s an attractive proposition — being able to work from home and earn commission on sales, with the flexibility to work as little or as much as you want.

That’s the general allure of multi-level marketing companies, or MLMs, especially for Canadians looking for a side hustle to supplement their income or some extra cash as they parent at home.

But not all MLMs are the same, and they’re not a guaranteed source of income, experts say, which is why you need to do your homework before signing on the dotted line.

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“If it sounds too good to be true, it probably is,” said Kenneth Wong, a faculty member at the Smith School of Business.

A multi-level marketing company is a form of direct selling where sellers not only sell goods or services, but also sponsor new sellers, and can receive additional income to compensate them for leading their own team, according to the Direct Sellers Association of Canada.

Multi-level marketing companies are legal in Canada — but pyramid schemes are not.

The Competition Bureau says pyramid selling focuses primarily on generating profits from recruiting rather than sales, while MLMs are focused on selling their product.

There are rules about what MLMs can and cannot do. For example, it’s illegal for them to offer compensation for recruitment, require purchases for participation other than a startup kit, require an unreasonable amount of inventory holding, or fail to offer a reasonable buyback guarantee, the bureau says on its website.

It might sound easy, but selling and recruiting are a lot of work, said financial educator Jessica Moorhouse. And while you might be able to start by selling to friends and family, they likely can’t sustain your business — and you also risk damaging those relationships.

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“I think a lot of people that are targeted for these are vulnerable people. They need the money, and so they think this is their ticket out of their situation,” said Moorhouse.

“They could just end up in further debt if they can’t sell these products.”

There are more than 100 companies that use the direct selling model in Canada, according to the Direct Sellers Association, and 1.1 million independent salespeople, 84 per cent of whom are female. Seventy-two per cent of those salespeople derive less than 10 per cent of their household income from direct selling.

MLMs in Canada have to disclose the typical compensation participants receive, according to the Competition Bureau.

Arbonne’s disclosure for Canada says in 2023, the median annual earnings for independent consultants was $187 and the average was $359. The company says participants make their earnings from commissions, overrides (earnings on their team’s product sales) and performance-based awards.

However, the average for the top 50 sellers was $2,873. Arbonne notes those figures don’t include business expenses.

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Though the difference between an MLM and a pyramid scheme seems clear on paper, Wong said there are several red flags to watch out for that could mean an MLM company is actually a pyramid scheme, or perhaps operating in a grey area.

First, keep your eye out for extravagant promises, he said. You should also be wary of companies that seem to focus more on recruitment than on actually selling the product.

If promoters are using high-pressure sales tactics, such as telling you to “act now or you’ll lose the opportunity,” that’s another red flag, said Wong.

Another warning sign is if sellers are told they have to hold inventory much greater than what they can realistically sell, said Wong.

In addition, a good company should be helping you make a sales plan, said Wong, not just throwing you in the deep end.

“If you’re not being given (a plan), or being given assistance in developing one, they don’t really care about how well you do,” he said.

The Direct Sellers Association says promises of wealth, large upfront membership or entrance fees, buried high costs in the form of starter kits or training, and a focus on recruitment are all indications that you’re looking at a pyramid scheme and not an MLM.

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If you’re interested in joining an MLM, Wong said you need to do your homework first: look up the company, and research what people are saying about it on social media. You can even speak with sellers and ask them about their experience and their earnings.

You should also seek out people who have left the company, added Moorhouse.

“Talk to some people who used to do it and left, and find out why, just so you understand what are some of the potential pitfalls and risks involved.”

You should also check whether the company will refund you for unsold inventory, Wong said.

Take a look at the actual product being sold, said Moorhouse — it should be not only genuinely good, but also different from what people can buy conventionally. It also shouldn’t be based on a current trend, she added, but be something that will still be an attractive product over a longer period of time.

“If it’s brand new, and the things that they’re offering are very trendy, that could be a sign that they’re in it just to get a bunch of people to join, take their money and close down business,” she said.

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