January 20, 2007

What Is A Pyramid Scam?

I see a lot of questions online from people wondering what pyramid scams are and how they can avoid being taken by one.

So with that in mind, here's some updated information on pyramid scams, as well as some tips to help you avoid being scammed by one.

What is a Pyramid Scam?

A pyramid scam (technically called a "Pyramid scheme") is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme - usually without any product or service being delivered.

Pyramid scams, which are also referred to as franchise fraud, or chain referral schemes, are marketing and investment frauds in which an individual is offered a distributorship or franchise to market a particular product.

The real profit is earned NOT by the sale of the product, but by the sale of NEW distributorships. Emphasis on selling distributorships or franchises, rather than the product or service, eventually leads to a point where the supply of potential investors is exhausted and the pyramid collapses, causing everyone to lose their money.

At the heart of each pyramid scam there's typically a representation that new participants can recoup their original investments by introducing two or more prospects to make the same investment. Unfortunately, promoters fail to tell prospective participants that this is mathematically impossible for everyone to achieve since some participants drop out, while others recoup their original investments, and then drop out.

Basic Pyramid Scam Criteria

Basically, under the law, a business opportunity or business model that meets the following criteria is an illegal pyramid scam:

  • You must make an investment to get the right to recruit.
  • When you recruit another person into the program, you receive what the law calls "consideration". That usually means money, but can be anything else of value.
  • Your new recruits must make an investment to get the right to recruit, and they also receive something of value for getting other people to join.

Note: Most Network Marketing and MLM (Multi-level Marketing) companies are NOT illegal pyramid scams. Though their actual structure, when diagrammed or drawn out, may have the "shape" of a pyramid, they are fully legitimate and legal businesses.

In fact, companies like Coca-Cola, Colgate, MCI, Microsoft, Toyota and Xerox, to name a few, now distribute some or all of their products and services by utilizing a Network Marketing business model.

Tips for Avoiding Pyramid Scams

  • Be wary of "business opportunities" to invest your money in franchises, distributorships or investments that require you to bring in subsequent investors to increase your profit or recoup your initial investment.
  • Independently verify the legitimacy of any company or business opportunity before you invest your money!
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  1. Great information here.

  2. Thanks Susan! And thanks for visiting HBT.

    Shine on,

  3. Hi. Found your blog through Google. I agree with Susan, there's a lot of helpful information here.

  4. Very helpful Aaron. I'll put a link to this on my business forum.

    Take care,

  5. You bet! I'm glad I could be of help. :)

    The more people know this information the less chance there is of them losing their money in a scam. And that's important to me.

    Shine on,

  6. AnonymousJune 09, 2007

    Thanks for posting this.



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