Herbalife: Why I Made It a 35% Position after the Bill Ackman Bear Raid

This is a guest post prepared by Robert Chapman. Chapman is the founder of Chapman Capital LLC, which is a Los Angeles based investment company specializing in takeovers and turnarounds. In 2000, Chapman Capital was an activist versus Herbalife following the death of Herbalife’s founder Mark Hughes. This is an amazing article. It’s well-researched and easy to understand.  If you’re remotely curious about the future of Herbalife after Ackman’s attack, the mechanics of short selling and the potential value of Herbalife’s stock, this is a MUST read. If you find this article informative, hit the +1 or Like buttons above. Sincerely, +Kevin Thompson

Note: Note: Below is the opinion of Chapman Capital LLC and is not a recommendation or an indication of Chapman Capital’s current or future intent to buy, sell or otherwise transact in Herbalife common shares.

Update: Robert Chapman made some slight revisions to the article. His points are the same; however, he made a few stylistic changes.

As anyone even remotely connected to the world of multi level marketing is surely aware, the perpetually sanctimonious Bill Ackman and his extremely successful investment advisory firm Pershing Square formally launched a massive bear raid on Herbalife (HLF) on 12/20/2012, conducting a 3+ hour, media-packed, web-streamed 300+ PowerPoint slide deck presentation in New York after first selling short 20MM HLF shares for as estimated $1 billion plus in proceeds.   In his presentation and numerous interviews with the business media that day, Ackman declared a target price of zero for HLF’s shares.  In other words, he claims to be so convinced that Herbalife operates an illegal pyramid scheme, he is certain that government authorities and/or HLF’s distributors/salespeople/customers will shortly put the company out of business.

SUMMARY INVESTMENT THESIS: Despite beguiling and specious reasoning, Ackman will fail to influence/cause a material regulatory response or a HLF distributor exodus. Consequently, he will suffer a merciless short squeeze, catalyzed and augmented by a fast and furious combination of HLF share count shrinkage (buyback) and excellent operating performance (beat and raise dynamic).

REGUATORY SUMMARY: FTC has been there, done that.

The Ackman Tell. Many poker games are won and lost upon that infamous turning point when a player properly reads his opponent’s “tell.” To wit, I am confident that during an interview with CNBC’s Andrew Ross Sorkin on “D-Day” (12/20/2012), Bill Ackman slipped his “tell”, confirming my suspicion that he already realized the FTC wasn’t going to make his day by shutting down HLF. I strongly recommend all HLF traders/investors read the transcript of this interview, as Sorkin does a masterful job of fighting the media urge to genuflect before Ackman’s drawn down zipper, otherwise known as “The Whitney Tilson”. Specifically, Sorkin, after hammering Ackman, asked toward the end of this interview, “This is somewhat dependent on the FTC taking action. If they don’t, what happens?” Now, remember that Ackman’s entire thesis rests on his certitude (so he claims) that HLF is an illegal pyramid scheme, which the FTC has a mandate to shut down. If you were 100% certain (with 20% of HLF shorted in your funds alone) of this claim, wouldn’t your answer be, “There is no way the FTC doesn’t take action to shut down the illegal pyramid scheme run by Herbalife.” Instead, Ackman diffidently responds, “I think the FTC is going to take a very hard look. But I think most importantly the new distributor someone is trying to suck into the scheme will be better informed …”

The moment I read this response, after having researched HLF on/off since 2000 (when Chapman Capital had been an activist in HERBA/HERBB shares during Mark Hughes’ LBO efforts), I decided I had to place a monster long bet on HLF. I believe Ackman already had concluded the FTC wasn’t going to assist his crusade. Instead, he realized that he had to focus on existing and prospective HLF distributors, praying the media attention would have a materially deleterious impact on any decision to join or to continue with the HLF team. Indeed, without the FTC taking injunctive actions against HLF, Ackman’s crusade toward “zero” is doomed.

Here are key bullet points on the lack of real regulatory risk to HLF shares:

Internal Consumption Issue Already Clarified/Resolved by FTC in 2004: “the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme” is a quote from an FTC letter dated 01/14/2004. Essentially, the letter states that if a product is marketable, the FTC is OK with the MLM, making Einhorn’s 05/01/2012 call focusing questions on this internal consumption issue far less relevant than was (mis)understood.

FTC Material Adverse Actions Near Zero Probability:  during my due diligence, I spoke with the country’s top lawyer specializing in MLM/regulatory dynamics. During our conversation, he offered his legal opinion, pointedly stating that there won’t be any FTC injunction, much less any regulatory action to put HLF out of business (“hell freezes over before this happens”). If there is regulatory action of any kind, it simply will be some type of consent order/settlement addressing better disclosure.

Few Consumer Complaints:  the FTC has not received many consumer complaints on HLF products – only 37 in 2010, 36 in 2009, and YTD 05/2012 was only 18 (again around 40 annually).

HLF is Big, Time Tested Veteran:  the FTC can and will shut down companies violating MLM rules, just as it did BurnLounge (online music retailer) in 03/2012 and Equinox in 2000. While such action is rare, the FTC will act aggressively to shut down companies when it sees the need. During the 32 years of HLF’s existence, the FTC has yet to see the need to pursue Herbalife.

Ackman Relied Greatly on Old Cases, Leaving Out Material Facts – Ackman failed point out that the FTC has already commented about the relevance (or lack thereof) of the cases he referenced in his presentation. In fact, most of the post Einhorn reporting has been misleading information;

No Federal Clarity – lots of Grey:  No “bright line” federal statute against pyramid schemes; even the guy with jihad against MLM’s, Pyramid Scheme Alert’s Robert FitzPatrick, conceded that FTC decided too complex to regulate MLM’s in 09/2011 and other anti-MLM consumer protectors have as well; this MLM lawyer thinks DSA should fight for bright line federal standards to eliminate opportunity for short sellers to exploit the grey;

Vast Preponderance of Sales and Growth are International (i.e., Outside Ackman/FTC): 80% of HLF’s business overseas.

The DSA is an Effective Lobby: The DSA serves as a lobbying entity designed to protect the MLM industry from burdensome government regulations. It led a campaign in 2006 where 17,000 comments were submitted to the FTC, all requesting an exemption from the restrictive requirements in the Business Opportunity rule. The DSA was successful. The DSA is more powerful that Ackman’s ally, Pyramid Scheme Alert’s Robert FitzPatrick

DISTRIBUTOR SUMMARY:  “Bill who?”

Chapman Capital’s distributor surveys show no meaningful percentage of distributors had even heard about Ackman’s circus show. Moreover, their evangelical commitment to HLF and confusion as to what 300+ pages of PowerPoint means seem to be causing an acceleration of business growth. Ackman’s payment for Google Ads (pegged to “Herbalife” search) exhibits his desperation to influence distributors, efforts which appear to have negligible effect.

TAILWINDS — FAT TAILS AND BUSINESS BAILS  HLF has two secular tailwinds in its favor: lots of fat people (fat “tails”) and no shortage of structurally un/underemployed humans. In fact, one thought for a short in HLF to consider is the following: net/net, does the U.S. government benefit from fewer overweight Americans (lower insurance costs) and fewer people standing in unemployment lines (ever hear of a fiscal cliff problem with U.S. budget?)? If the U.S. government benefits from HLF’s impact on the country’s physical and fiscal health, while enduring only 40 complaints/year about HLF, why shut down HLF? Ponder that for a moment.

BACKGROUND: Short seller roadkill HLF shares were trading as high as $45/share on 12/14/2012, and had been over $70/share (a high teens P/E multiple) earlier this year before the highly respected investor David Einhorn of Greenlight Capital asked some leading questions on an earnings call that implied he was skeptical that Herbalife was operating within the Amway safe harbor guidelines for multi-level marketers. Fear of Einhorn’s excellent record of identifying overvalued short sale targets sent HLF shares into the $40’s in the spring. In contrast, Ackman has been somewhat vague as to when he built the preponderance of his short position (i.e., did he start before Einhorn’s 05/01/2012 questions or was he an unoriginal shadow to Einhorn’s trailblazing?), but I am guessing $50-55/share is his average short cost basis. There is no evidence Einhorn went short at that time or since, but I would be shocked if Greenlight would maintain HLF short positions anywhere near $30/share based on HLF’s international value alone.

Open interest on HLF puts accelerated and the stock’s relative weakness worsened in the fall of 2012 as, I suspect – No evidence here. I’ve just been around the block a few times – people “around” Ackman shorted HLF or bought HLF puts ahead of 12/20/2012 presentation. In fact, I have a pet theory that Ackman’s interest in going massively public was heightened (if not driven) by the HLF stock’s reasonably strong response (into mid-$50/share) attendant with impressive late July and October 2012 financial results. Essentially, my hypothesis is that Ackman, with overall 2012 performance impaired by JCP’s descent into the teens, came to conclude he needed a big winner before year-end 2012.

As word leaked into the market of Ackman’s intention to present publicly the bear case on Herbalife, the stock began a gradual decline, then fell suddenly from ~$41/share to $36/share in the closing market hours of 12/19/2012, when a CNBC reporter with big hair reported that market rumors were true. The next morning, as the PT Barnum of the hedge fund industry delivered his presentation in a New York hotel ballroom on 12/20/2012, and especially through the early trading hours of 12/21/2012 (a very illiquid trading day), the shares went into free fall, reaching a nadir of $24.40/share. My funds made their last purchases at $25.30/share in a brief but painful period of negative marks. HLF shares have since rebounded to ~$30/share as traders/investors have taken a closer look at whether the emperor is running around New York denuded (figuratively speaking . . . fortunately).

ACKMAN’S TIMING OF “INTEREST” Ackman’s end-of-same-year-that-Einhorn-showed-up timing was masterful – when it comes to the power of influence, only top hypnotists can compete. A classic bear raid involves creating abject panic in the market. Concurrently using the proximity to Christmas, the December option expiration, and the depth of his presentation, the Ackman impact on the shares was maximized. The last ten days of December are as quiet as it gets on Wall Street, with most decision makers leaving for vacation, drying up market depth and liquidity. Also, at the peak of the panic not many institutional investors felt the urge to have HLF show up in their 12/31/2012 Form 13-F filing. December is also the final month of HLF’s fiscal year, which puts them in a “blackout period,” prohibiting the company and insiders from repurchasing shares under the $950mm authorized buyback. Moreover, due to the extensive audit period that attends year-end, it will be several months before year-end 2012 results were reported. This blackout removes HLF’s most effective defense to the bear raid: executing a nearly $1 billion share repurchase authorization. Again, if timing is everything, Ackman is every woman (with a nod to Whitney Houston).

PERSHING SQUARE/ACKMAN RESUME:  Let’s review some history on Bill Ackman and Pershing Square, some color on the mechanics of short selling, and Herbalife’s response to the bear raid to date.

Bill Ackman manages a New York based hedge fund called Pershing Square with exceptionally good long-term results. Ackman is not known as a short seller. His fund is generally a long-biased fund. He achieved some notoriety for predicting that muni-bond insurer MBIA was undercapitalized, which eventually proved true during the financial crisis of 2007-2009. His enormous investment in General Growth Properties (GGP) at less than $1/share remains one of the most impressive brains/balls combinations I have ever seen. All the while, however, his ego seems boundless.

He is somewhat unusual among usually media averse hedge fund managers in that his strategy involves publicly trumpeting the merits (and genius) of his investments, which he generally holds for a long time. He manages a concentrated portfolio comprised of very few, very large investments. He also is considered an activist investor. He frequently badgers the board and management of the companies in which he invests with what start as suggestions and frequently escalate to demands as to how they should conduct their business, what their capital structure should be, and the composition of its board.

Though he will rarely, if ever, publicly concede, Ackman makes mistakes just like the rest of us, even catastrophic financial ones (e.g., call options on Target). Indeed, Ackman closed down a previous hedge fund advisory entity called Gotham Partners after he reportedly marooned his investment funds in an illiquid and devastating combination of a closely held REIT (First Union Real Estate) and a portfolio of golf courses (Gotham Golf) for which no exit was possible. So while Ackman is quite good at what he does for a living, his hubris makes him vulnerable to spectacular failure. He has a high financial IQ, but it may be the delusional and narcissistically 15 surplus IQ points he awards himself that have been, and may again be, his undoing. Think of him as the Reggie Jackson (I’m dating myself here) of Wall Street: he swings for the fences, but can cause a lot of pain and break a lot of hearts – or the bank – when he whiffs.

SHORT SELLING PRIMER: A bit more on short selling for those inexperienced in the sport. Short selling is a vital component of the markets. The ability of investors to sell short shares of overvalued companies keeps market valuations in check, and permits investors to hold hedged portfolios that are not dependent on constantly rising indices to make a positive return. There are risks, however, of going short that do not exist on the long side. For instance, if one purchases the shares of Acme Widget at $10/share, and Acme fails, you know precisely how much you will lose – your $10/share, and no more. If you were to short Acme Widget at $10/share and Acme were to discover a vast plutonium mine under their headquarters, those shares that were shorted at $10/share may have to be repurchased in the market at $100/share, $500/share, or even $1,000/share. The potential loss on a short sale is unlimited. For this reason, most professional long/short investors keep the size of their short positions much smaller than their long positions. For instance, if a core long position is 5% of capital, a core short may be 2%. Last week in Barron’s, famed short seller Jim Chanos discussed his lessons learned from the 1999-2000 internet bubble when he saw his AOL short go up eight times in value in his face. The lesson he drew was to keep individual shorts small relative to capital. Ackman’s $1 billion short in Herbalife is almost 10% of his reported $11 billion fund. If he is wrong, he may very well be putting his firm at risk due to the enormity of his short position relative to both Pershing Square’s and HLF’s size, and the potential difficulty of covering a short position of that magnitude in a “short squeeze”. Google the notorious Volkswagen/Porsche trade to see how dramatically these events can play out at the extremes.

To go short a company’s stock, one must borrow the shares to sell from a broker. Shorting without a proper borrow is called “naked shorting”, and is illegal. Holders of stock give their broker the right to lend out their shares in exchange for the flexibility of keeping margin accounts, and to participate in a portion of the fees short sellers incur for access to those shares. Short selling is conducted by the investor calling his broker, securing a borrow, and then executing the sale. Most companies have ample shares available to borrow, and this process yields little drama. However, in the case of controversial stocks, the demand to borrow shares may exceed the supply in the brokers “box”. If long holders sell shares brokers had out on loan to short sellers, the short seller must replace those borrowed shares he has lost access to with newly sourced shares. Should none be found, he will be forced to cover that portion of his position, and if unwilling to cover, the broker will involuntarily “buy him in”. This dynamic is what leads to short squeezes, where heavily shorted issues rapidly appreciate in the absence of any fundamental reason. Just look back to 2008 when the US government suddenly prohibited the shorting of financial stocks to see how painful that result can be for short sellers.

One effective defense for the short seller would be to have his broker contract on his behalf with a lender of shares to provide a quantity of shares for a specific term, at a negotiated payment. This insulates the short seller from buy-in risk for the duration of the contract. However, these contracts are individually negotiated, and somewhat rare. Also, they frequently permit the long holder to regain access to his shares if the company were to, for instance, conduct a self-tender offer for its shares. It is not known if Ackman has such an arrangement.

Ackman’s self-reported short position of 20 million HLF shares is over 75% of the reported short interest in Herbalife. At this point, the “borrow is tight” – there appears to be a near zero supply of shares available to sell short. The few brokers that will supply a borrow are charging as much as 20% of the value of the short annually for that access. This is a monster number – between the 20% negative-borrow and HLF’s dividend, it would cost nearly 25% each year to stay short HLF, all things remaining constant on those two variables.

HLF’s DEFENSE IS COMING:  Given the holiday timing, the best defense HLF has been able to muster has been to put a video of CEO Mike Johnson on its IR webpage defending the company broadly, and to schedule an investors’ day two weeks later, for 01/10/2013 in New York to address Ackman’s accusations in detail. The company has hired an impressive team of advisors. While most would have expected Bank of America/Merrill Lynch to get the assignment given their execution of last spring’s $400mm share repurchase, the task has been given to Moelis & Company, a well regarded, Los Angeles-based boutique investment banking firm. The firm’s namesake, Ken Moelis, is a disciple of Mike Milken from the height of Drexel Burnham’s power in the mid-1980’s. Moelis went on to a successful career at DLJ and UBS, where he became the premier investment banker to the casino gaming world, before launching his own shop.

Additionally, Herbalife has reportedly hired Boies, Shiller & Flexner the law firm founded by famed litigator David Boies. Consider Boies’ HLF team to be the Navy Seals Team 6 of litigation – you really don’t want them on the other side of your war. Note, I have no evidence that Bill Ackman is related to Osama bin Laden, and thus worthy of being targeted by DEVGRU (figuratively speaking, of course).

HLF promises a detailed rebuttal of the Ackman allegations on 01/10/2013, and I expect it will blow away the skeptics with a point-by-point dissection of Ackman’s claims. I presume Boies was brought on to bring suit against Ackman for some combination of libel, slander, defamation, tortuous interference and other imaginative causes of action. No matter how this turns out, the discovery, depositions and testimony should be highly enlightening and probably quite entertaining.

HLF’s DIRT CHEAP VALUATION:  So now, how might one value the shares of HLF in the bull case where Ackman is convincingly discredited by HLF CEO Johnson (a singular American bad-ass, according to my sources who know him personally here in L.A.) on 01/10/2013, and the market no longer ascribes risk to the feared FTC intervention (if I hear “headline risk” one more time …). EBITDA is a preferred valuation metric for a company like HLF that doesn’t have heavy capital expenditure requirements, and converts much of its reported earnings to cash that can be distributed as dividends or used to repurchase shares. Herbalife will produce over $725mm of earnings before interest, depreciation, and amortization (EBITDA) this year, a growth-stock worthy increase from $634mm in 2011 and $480mm in 2010. The few analysts that cover the stock project $800mm in 2013. Think of HLF’s gushing cash flow this way – HLF is printing EBITDA of over $2mm/day. That’s a heck of a lotta cheese with which to fight Ackman, who has and will be spending his own and his investors’ money on litigation and other matters (which won’t bother his limited partners until the stock is going up on a daily basis). HLF is lightly leveraged, with $500mm of bank debt, and quite liquid with $700mm of unused borrowing capacity and $300mm of cash. HLF currently pays $1.20/share in dividends annually on its ~108 million shares outstanding.

In the absence of controversy, the market would typically accord a fast growing, capital efficient company such as HLF a premium multiple. Let’s just assume the S&P 500 index current multiple of 8x EBITDA. This would yield a total enterprise value of 8x $725 of EBITDA = $5.8B. Deducting ~$500 million of debt, but giving credit for $150 of the cash (that is excess to the operating needs of the business), would yield a total equity value of $5.45B, which divided by the 108mm shares works out to $50.46/share. The current price of ~$30/share implies an EBITDA multiple of 4.7x. Tupperware, which is a MLM free from controversy, trades at 9.3x EBITDA, and Avon trades slightly higher. At $50/share, the share still would sport a dividend yield of 2.4%. Herbalife should report net income of about $4 per share this year and $4.50 in 2013 (ignoring the massive buyback I see coming). $30/share implies a 2012 P/E multiple of around 7x. The current S&P multiple is about 13x. For a company growing 15%+, you would expect to see a premium multiple, which is why brokerage firm analysts who cover the stock have target prices from $65 to $101. My valuation is lower, but should the Ackman-induced cloud be lifted, I can’t say those targets are absurd.

In fact, between the technical short squeeze that is in the making, the massively accretive impact of a $1B buyback, and the FTC risk fading away, I can’t say that I’d be surprised to see HLF trade back to its old highs of $70/share. If HLF has $500mm of 2013 net income, and buys back 30mm of around 110mm shares, the ultra-low interest rate environment makes the net income impact from interest expense miniscule (the HLF 13% EPS yield is 3-4x borrowing costs). Getting over $6/share in EPS is really not that hard to financially engineer, and between the short squeeze, comparable valuations, a below-market 11-12 P/E multiple would take HLF back into the $70s. Indeed, it could turn out even more financially salubrious than even these scenarios.

Ackman’s essentially fired nuclear missiles at HLF’s business model and its legality. When (and not “if”) HLF’s regulators and distributors essentially blow off Ackman’s claims as either old or no news, HLF will for all intents/purposes become bulletproof and battle tested. This may/should garner it a higher valuation than before Einhorn or Ackman ever showed up. That “what if” scenario gets you a $100/share stock price potential (again, only 15x $6-7/share in EPS gets you there; I’m not talking about a NFLX-level valuation here).

This hypothetical rally toward triple digits is not farfetched. In the event of a self-tender by HLF, or even without one, should the large institutional shareholders proactively remove their shares from the stock loan supply, there is great potential for short sellers being forced to cover as the borrow dries up. A panic to the upside could occur as the shorts are forced to buy in 25 million shares in a market unable to induce that many sellers. I am sure HLF and its capable teams of advisors are looking at the myriad of options to create value out of the chaos caused by this spectacular bear raid. Indeed, it does not take great imagination to see what could make these numbers dance.

In addition, Ackman has no shortage of enemies from my own polling of the audience. The odds favor Herbalife in this aspect of the battle. Ackman truly went all-in telling the world he has shorted ~20% of a relatively unlevered company trading at ~4x EBITDA.

BUT WHAT IF ACKMAN IS RIGHT?  His target price of zero implies the company is shut down globally, not just here in the US, which comprises only 20% of HLF’s global revenue. Is it possible? I guess so, but in my view no more than a very slim probability. More probable, in the unlikely case the FTC responds to Ackman’s presentation and reopens the same issues they have been policing for 32 years in the case of HLF, it is possible that the company could be forced to change some elements of how it conducts business in the US, and maybe elsewhere, leading to lower sales and margins. No doubt this would spook the market with fears that there was even more scrutiny to come, leading the market to value Herbalife at a discounted multiple on reduced earnings.
So let’s take a cut at that. Let’s say the FTC somehow compels business practice changes that reduce sales by 20% and lead to current pre-tax margins contracting by 25%. This would yield EBITDA of approximately $450mm, which at 5x would yield a share price of $17. Personally, I think there is about a 10% chance of this outcome. So weighting a 10% chance of $17/share, and a 90% chance of $50/share, I come up with a fair value of $47/share, which is why I own a boatload of shares purchased into the panic created by the bear raid. In fact, there is far more likelihood of another LBO of HLF (Golden Gate/Whitney stole it the first time around) than any other “headline risk.”

Ackman took his shot; now it is HLF’s turn.

DSA Convention 2012 – Inspiring Entrepreneurs

This year’s DSA annual meeting was held in Dallas, Texas. It was a really cool event! We had phenomenal speakers, the best being none other than George W. Bush. I was skeptical before joining the DSA two years ago. I’m just not a “trade association” kind of guy. I’m so happy I joined! It’s a great organization charged with a complicated and important task of representing the interests of a very diverse industry. While I give the DSA a hard time about not doing enough with respect to the DSA’s pyramid legislation, I understand that it’s hard for a trade association to pivot when it’s trying to appease hundreds of companies, each with a unique set of needs and concerns.

Below are some of my favorite pictures from the DSA convention.

IMG 4896

I have a lot of respect for Richard Bliss Brooke. He’s been very supportive of my participation in the DSA.  He encouraged me to get involved in both the Ethics Committee and the Government Relations Committee.  As someone that wanted to positively impact the direct sales community, getting involved with those committees was a crucial first step. He also gave me a kick in the ass to get started on my book. I made a commitment to get the content done by September 3. I’ve got a lot of work to do!

IMG 4897

Joe Mariano is someone else I hold in high esteem.  As the president of the DSA, he’s got a very challenging job. As a trade association, the DSA is comprised of over 100 member companies and a few hundred supplier members.  He’s got the difficult job of aggregating the collective will of that community while leading a team that follows legislation all across the country.  It’s really incredible when you think about the complexity of the entire operation. Joe has been very generous in allowing me to be part of the important conversations about the industry.  

Gerald Nehra is one of the kindest men I’ve ever met.  He’s also a great competitor.  He was one of the original MLM attorneys.  Without him, I’m not sure if I’d be having as much fun right now.  And he’s got a very kind, loving and generous wife.  For two years straight, I’ve attended the convention stag.  I’ve never been able to bring my wife, which makes it weird showing up at a party solo.  Both years, Gerry found me and invited me to sit at his table. I always enjoy chatting with him and his partner, Richard.  In reality, there’s only a handful of competitors that are serious players in the industry. Nehra and Waak are two of them.

By far, The most moving moment was when Rich DeVos welcomed his two boys, Rich and Doug, into the DSA Hall of Fame. I’ll be honest….I shed a tear or two. As a father of three children, I was simply amazed at the unique moment Rich DeVos got to share with his two sons. It made me assess my path and wonder if I was on track to leave a lasting legacy for my children as Rich has done for his. With Rich on stage, telling stories about the start of Amway, and seeing the pride in his eyes when his boys took the stage…it was just awesome. I recorded his speech, without permission. I’m not sure if that’s ok. But until someone says otherwise, check it out below.

This is my full library of pictures from the DSA event.  Unfortunately, I didn’t take very many.

Living the Island Life and 7 Traits of Successful Companies

IMG 3404I had the privilege of speaking at the Island Life launch party in Cocoa Beach, Florida. It was an exciting trip! I packed up the family and made a little vacation out of it. Buca and I have been friends for a couple of years and I was excited to hear the news about he and his partner starting their own company. Buca will tell you straight up, the Island Life culture is not for everyone. When the first item on the itinerary was a BBQ with an ocean view and the last item was a karaoke costume party, it was pretty apparent that Buca was injecting his signature in the DNA of the business. Because he’s so focused on a unique distributor experience, it just might work.

I also had the pleasure of hanging out with Doug Wead, networking great and Senior Advisor to the Ron Paul campaign.

At the event, I gave a talk about the seven traits successful companies have in common. I threw together the video below to serve as the highlights. It’s not the best production quality but I think you’ll enjoy the content. I’ll package this in a more professional manner in the future and re-ship. But for now, catch a glimpse. The seven traits are also listed below. Take care, for now.

1) Leadership
2) Product
3) Design
4) Systems
5) Compliance
6) Capital
7) Field

Self Deception: a cancer holding the MLM industry back

It’s a strong title, I know.  But it’s true.  We all suffer from “self deception” to a certain extent.  It’s a trick we play on ourselves to shift accountability. We tell ourselves that we’ll start that diet….next week.  We tell ourselves that we lack the time to read and learn new skills.  We tell ourselves that exceptional people are just born exceptional.  We tell ourselves that we need just a little more education and work experience before we start our own businesses.  We give ourselves every possible excuse to maintain our view of the world.  Change is scary.  It hurts; hence the saying “no pain, no gain.”  Yet, there’s no way around it.  Change is a prerequisite for progress.  Strong leadership is required to ensure that the RIGHT kind of change is being pursued.  Right now in the MLM industry, we’re heading in the wrong direction, in my opinion.  I’m just calling it like I see it.  I’ll admit, I’m part of the problem.  I’ve got leadership positions and I’ve done a poor job at communicating the scope of the problem.

So what’s the problem?

We need clearer standards.  The MLM industry is cloaked in a veil of ambiguous law where there’s an ocean of gray separating legitimate companies from pyramid schemes.  I was prompted to write this article based on the industry’s response to the BurnLounge Final Order (click here for a summary of the BurnLounge decision).  Since BurnLounge’s fate was officially sealed when the final order hit last month (pending an appeal), people are now figuratively saying “yeah, I always knew those guys were really stupid.  After all, their product could not really stand on its own in the marketplace.”  (See comment above about self deception).  And now, people are rightfully unnerved by some verbiage in the BurnLounge order.  In particular, the Order defines a “Prohibited Marketing Scheme” as:

[A]n illegal pyramid sales scheme . . . in which participants pay money or valuable consideration in return for which they obtain the right to receive rewards for recruiting other participants into the program, and those rewards are unrelated to the sale of products or services to ultimate users.  For purposes of this definition, a sale of products or services to ultimate users€ DOES NOT include sales to other participants or recruits or to the participants own accounts. (emphasis mine).

In other words, according to this Order, it’s illegal to pay commissions on volume consumed by other participants in the downline. This is a practice EVERYONE does, across the board. In fact, in it’s advisory letter to the DSA, the FTC has stated this is fine.

Consequence of the BurnLounge Order?

Before you lose sleep over the BurnLounge Order, keep in mind this definition is not automatically binding for future decisions.  It has no authoritative value beyond this Order.  But what if a judge with an axe to grind against the industry wants to adopt a similar interpretation of “Illegal Pyramid Scheme?”  And what about your future customers?  What if they come across this definition?  It could easily be interpreted as the law of the land, causing more confusion and disharmony in the industry.  Someone could very easily read it and falsely think, “Huh, that makes sense.” Whether it carries authoritative value or not, I’m not comfortable with this definition inked on an Order.

But here’s the kicker.  Given the ambiguity in the law, what do we expect?  What IS the definition of a pyramid scheme? It’s basically been boiled down to a “you know it when you see it” test.  Universally, we all agree that products in the industry need to have the ability to stand on their own in the marketplace irrespective of the compensation plan.  So we all admit that there’s needs to be SOME revenue attributable to outside customers i.e. people unaffiliated with the program.  In the BurnLounge case, only 3% of its revenue came from customers.  How much is enough?  There’s no firm answer.

Was BurnLounge really that different?

While we’re coming up with reasons to distinguish BurnLounge from the rest of the companies in the MLM industry, I see more similarities than differences.  While they made some very stupid mistakes, whether it be by bad counsel or corporate hubris, at the end of the day, they were buried by their paltry customer numbers.

So how do we respond?  How do we improve?

One option is to seek peace. To try to convince ourselves that the owners were simply reckless. The better option would be to seek improvement by having an honest conversation about the problem.  While we easily roll BurnLounge under the bus and reference their junk products as the main reason for their demise, we should at least acknowledge, industry-wide, the major importance of accruing revenue from external customers.  When proving the marketability of a product, the only metric that really matters is revenue from customers.  More is better.  While we all agree that BurnLounge was a bad business, we need to have an honest discussion about WHY it was a bad business.  And all roads leads to the offering of a legitimate product with true value.

Instead…

We’re trying to “get tough on crime” by passing legislation that would effectively legitimize a model very much like BurnLounge.  Instead of shrinking the gray and increasing the standards in the industry, we’re falling back to old tricks, talking about resurrecting old bills to “clarify” the ambiguity in the industry.  We all know the FTC and regulators want to see external sales.  So why are we even discussing old bills that obliterate all external sales obligations? The DSA model legislation, in my opinion, does not go far enough.  In the bill, it carves out an exception for an illegal pyramid scheme as:

(A) Nothing in this Act may be construed to prohibit a plan or operation, or to define a plan or operation as a pyramid promotional scheme, based on the fact that participants in the plan or operation give consideration in return for the right to receive compensation based upon purchases of goods, services, or intangible property by participants for personal use, consumption, or resale so long as the plan or operation does not promote or induce inventory loading and the plan or operation implements an appropriate inventory repurchase program.”  (emphasis mine).

Inventory loading is defined as:

The plan or operation requires or encourages its independent salespeople to purchase inventory in an amount, which exceeds that which the salesperson can expect to resell for ultimate consumption or to consume in a reasonable time period, or both.

It might take you a few times to read it to understand the gray area.  But basically, if the product gets consumed in reasonable quantities each month, the company is not a pyramid (in most cases).  Suppose we sell a membership to a Facebook-wannabe website.  In this business, we charge $10,000 per month to access a clunky social network, one that offers half of the features found on a free alternatives.  Is it “inventory loading?”  The site, after all, is being used.  What if we sold $10,000 shots of lemonade?  If people drink the lemonade, is it “inventory loading?”  Clearly, it’s a case of opportunity driven demand.  Clearly, it would be a BurnLounge-esque program where the lemonade is a token product concealing a money transfer scheme. I want to engage in a conversation with the DSA to simplify and tighten the current bill. One thing is for sure: nothing is going to get done on a legislative level without the DSA’s support.

HR 1220

And what about the congressional bill that was proposed in 2003, titled HR 1220 Anti-Pyramid Promotional Scheme Act?  In that bill, a similar definition of “Pyramid Scheme” is illustrated:

The term `pyramid promotional scheme’ means any plan or operation in which a participant gives consideration for the right to receive compensation that is derived primarily from the recruitment of other persons as participants in the plan or operation, rather than from the sales of goods, services, or intangible property to participants or by participants to others.

Again, the bill creates a carve-out that would allow a company like BurnLounge to skate by with NO retail sales to customers.

Before we complain about a judge’s dangerous definition of a “pyramid scheme,” we need to acknowledge that we’re not exactly helping ourselves by fighting for fewer safeguards.  If we’re not able to get on the same page regarding sensible standards, a judge will do it for us at the stroke of a pen.  Somewhere along the way, we’ve been convinced that it’s in our best interest to push for these sorts of solutions.  I’m telling you, we NEED to do better.

Saving the industry by defining the gray

When I first started my practice, I wrote an ebook titled “Saving the network marketing industry by defining the gray.”  The thesis is right there in the title.  The industry needs saving.  And it can only be saved by creating clear standards to distinguish good companies from the bad ones. And it’s going to take courage and a little bit of sacrifice.

Conclusion

There’s a lot of people upset at the verbiage in the BurnLounge order. The outrage makes sense. But…I think this Order is just the tip of the iceberg if we’re not able to improve the standards. And in order to improve the standards, we need to stop with the self-deception, pull ourselves out of the box and acknowledge the problem. If we do not find a viable solution to the problem, a judicial body will!

Proposed Solution

The sponsor relationship between a distributor and a new participant is the foundational element in the industry. How a participant is recruited generally dictates how they build the business in the future. The idea of recruiting someone and training them to only get on autoship and recruit more people is broken. In theory, when someone sponsors someone else, they’re committing themselves to teaching that new person how to move product and build an organization. Before they’re allowed to build an organization, it makes sense that they demonstrate SOME proficiency in selling product. Before I teach you how to sell soap, I should at least have some demonstrable results doing the same, right?

Until someone provides a better idea, I’m a believer in a required retail sales rule. Before someone can earn a bonus on downline volume, they must make a single sale each month to a nonparticipant customer. Keep in mind, this is only an idea. It’s not currently the law, so it’s perfectly fine for companies to operate without a retail sales rule. If each distributor were required to sell something, they’d think long and hard before joining a company with gratuitously inflated prices on the products. When Amway got in trouble in the UK, they were saved by their decision to require $200 in retail sales before someone can sponsor other participants. This incredibly high standard is not necessary here, but we can learn from it. In the 70s when Amway got into some heat with the FTC, they were saved largely by their retail sales rule. I drafted a proposed bill for Tennessee lawmakers a couple of years ago. I still think it advances the industry in the right direction.

The alternative: nothing gets done. If you’re not supportive of higher standards in the industry, at least stop complaining when judges create their own definitions.

What do you think?

Does the BurnLounge order concern you? What can we do to improve? If you learned something in this article, please hit the +1 button or “Like” it.

VanderSloot Denies Melaleuca Operates as a MLM

SMH.  It’s a new acronym I’ve recently learned.  It means “Shaking My Head.”  And that’s what I immediately did when I read about Melaleuca’s CEO, Frank VanderSloot, denying all ties to the MLM industry.

While it certainly seems like a ridiculous exercise, I list a few obvious reasons in the video why VanderSloot is wrong to make such a distinction.

In the video, I reference his statement to the press (included below). I also reference the FTC’s definition of a “Multilevel marketing program” as per the FTC vs. FUTURENET case.

Note, this is not a controlling definition given the circumstances of the case; however, it gives us a good idea of how the FTC defines a MLM.

FTC’s definition:

“Multi-level marketing program” means any marketing program in which participants pay money to the program promoter in return for which the participants obtain the right to (1) recruit additional participants, or to have additional participants placed by the promoter or any other person into the program participant’s downline, tree, cooperative, income center, or other similar program grouping; (2) sell goods or services; and (3) receive payment or other compensation; provided that: (a) the payments received by each program participant are derived primarily from retail sales of goods or services, and not from recruiting additional participants nor having additional participants placed into the program participant’s downline, tree, cooperative, income center, or other similar program grouping; and (b) the marketing program has instituted and enforces rules to ensure that it is not a plan in which participants earn profits primarily by the recruiting of additional participants rather than retail sales.”

Essentially, it boils down to whether there’s a recruitment component to a pay plan. If there’s an an opportunity for an override commission from downline productivity, where participants can sponsor other participants and earn income from their sales, it’s a MLM. Using the factors above, and some of the obvious factors referenced in the video, Melaleuca would clearly qualify as a MLM. There’s an enrollment fee that gives people the right to sponsor other participants (element #1) and the right to sell products (element #2), which gives people the ability to receive payment for product volume (element #3) assuming the commissions are not driven by enrollment fees.

VanderSloot’s Statement

(emphasis mine)

“It’s unfortunate that someone would suggest that Melaleuca is something like Amway. It’s not. We started Melaleuca 26 years ago to market environmentally responsible products and to provide a business opportunity for folks who weren’t successful in climbing the corporate ladder and didn’t inherit wealth from their parents. We try to be champions of the little guy. My father was a little guy. And I still see myself as a little guy.

Contrary to those who do not know us, our business model is nothing like Amway or Herbalife. I challenge anyone to find any similarity whatsoever. There is no investment of any kind unless you want to call a $29 membership fee an “investment.” And anyone can get a refund on that by just asking.

We do offer a home-based business opportunity. But it is no “pyramid scheme.” We have long been critical of the many MLM/pyramid schemes operating in this country. I agree with those who say that typical MLM companies destroy people’s finances. Most are designed to attract people to “invest” in large purchases with the promise of “getting rich” quickly by getting others to invest. The guy at the top always wins and the guy on the bottom always loses.

In Melaleuca’s case there is no investment and no getting others to invest. We do pay commissions to those who have referred customers based on what those customers purchase. There is really no way to lose money on referring customers. And there’s no way for customers to lose either when they’re buying high-quality products at grocery store prices. Customers just order the products they use every month directly from the factory. We have hundreds of thousands of customers who buy from us each month. They don’t ever resell anything. They don’t invest in any inventory. There can be no pyramiding without some kind of investment. In 26 years, no one has ever complained that they lost money. It’s simply not possible.

Our business model works pretty well for most folks. We have already paid over $2.9 billion in commissions to households across the country. Our mission is to enhance lives by helping people reach their goals regardless of their beliefs, backgrounds, or affiliations. Last month we sent out almost 200,000 checks to American households alone. Members of those households tell us we are doing a pretty good job achieving that mission.”

Can startup MLMs sell positions to fund their businesses?

This is an important question and one I get asked often by startup entrepreneurs: Can I sell top positions in my prelaunch business to fund it? To quote my least favorite answer from law school, the answer is:

it depends

On multiple occasions, I’ve been asked about the legality of three different methods. The first method is the most common: the selling of top positions i.e. pay $50,000 in exchange for a master position in the pay plan. In a nutshell, this arrangement would be categorized as a security. See below for more info on what constitutes a “security.” If something is a “security” it needs to be registered or fit within some sort of exception. If it’s not registered, a regulator can pursue a company for selling unregistered securities.

The second method is a little more elaborate and involves selling “revenue shares” in the compensation plan for x dollars. As an example, suppose Company ABC wants to create a revenue sharing pool whereby 1% of all company revenue gets skimmed into a separate revenue pool. Company ABC thereby makes available 3 spots to share in the revenue at a $50,000 charge per spot. Do the simple math and Company ABC can conceivably “raise” $150,000 with this method. Again, this would be considered a security.

The third option is the least common. It involves the charging of enrollment fees to give users an early enrollment option and access to a “beta” version of the product or service. With a successful “prelaunch” phase, the company can generate early interest and adequate revenue to scale out the business. Unless the core product is actually sold in these early days, commissions should never be cut. However, true value can still be provided in exchange for the enrollment fee; thus, bolstering the argument that it’s not a security.

What is a “Security?”

In the Securities and Exchange Act, the term “security” is defined broadly. If you want the full definition, click here. Warning: it’s boring beyond belief. Basically, for purposes of this analysis, the important question should be: what’s an investment contract? The U.S. Supreme Court addressed this issue a long time ago in 1946. The Court held an investment contract to be:

“A contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party.”

In the SEC’s case against MLM great, Glenn Turner, the court ignored the plain meaning of the word “solely” and held, “We adopt a more realistic test, whether the efforts made by people in the organization other than the investor are the undeniably significant ones, those essentially managerial efforts which affect the failure or success of the enterprise.”

Confused yet? But wait, there’s more!

Although the Howey Test represents the position of the Supreme Court and the Securities and Exchange Commission as well as a majority of the states, there are some states that apply an additional test. This is known as the “risk capital” test set forth by the California Supreme Court. There are only a few states that use this test; however, according to a colleague of mine, it’s worth knowing. The Hawaiian state supreme court provided the following factors to help clarify this test. Those factors are:

(1) An offeree furnishes money; and (2) a portion of this money is subjected to the risks of the enterprise (i.e. we’ll take this money and build the business with it); and, (3) the investor is promised a return on the investment as a result of the the enterprise (i.e. the investment will grow without the investor doing anything); and (4) the offeree does not receive the right to exercise practical and actual control over the decisions of the business.

Using the risk capital test, a classic example of a “security” would be the “sale” of membership dues for the development of a country club. If the club is simply an idea, the collection of membership fees on the promise of having a country club eventually might be considered a security. However, as pointed out in an American Bar Association article, timing is everything as to when the funds are collected. The article states,

Start quote The risk capital test looks at whether the money being put to work in a given venture will be used to develop or acquire the business or enterprise in which the interest is offered. If that test is satisfied, then such interest is deemed to be a security. Thus, a key factor under the risk capital test in determining whether what is offered and sold constitutes a security can be the extent of the development of the business at the time the interest is purchased.. . . [W]hen analyzing the purchase of a country club membership, it is possible that otherwise identical club memberships may be a security in the hands of one member and not in the hands of another member depending on the time the member acquired the membership and the maturity of the club itself at such time.” End quote

Again, the risk capital test is not used by the SEC and is only used in a few states. But when it’s a factor, it’s a factor when people collect funds in anticipation of fleshing out a concept. If there’s a little development behind the business, it might be a different outcome. In the MLM world, it could potentially be an issue if a company collected fees from participants (in the few states that actually use the test) without providing any value in return.

Translated in English

Can a company hypothetically sell top positions for $50,000 to help fund development?

Yes, but it would likely be illegal (unless they registered the security). Applying the Howey test (developed by the Supreme Court) referenced above, ask the following question: Is there a transaction where the person expects a return based on the efforts of other people? Using the looser standard published in the Glenn Turner case, the answer would undoubtedly be an emphatic “yes.” With a $50,000 payment, even if the investor intended on building the business, the payment would be considered a security assuming the business owner promised a lucrative return on the value of the position.

Can a company create a revenue pot to be divided between investors?

Same answer as above. In this scenario, there’s no fudging. When a top position is sold, there’s at least a tiny argument that the outcome of the investment will be largely influenced by the payor’s performance. In this scenario, the money is driven 100% by the performance of the company, not by the skill or talent of the investor. In this scenario, the business owner selling the hypothetical spots would undoubtedly show financial projections demonstrating the value of those spots i.e. “if we earn $15,000,000 in revenue, you would earn $x for your $50,000 payment” Clearly, this arrangement would be considered a security.

Can a company run a prelaunch and charge enrollment fees with the hopes of raising enough money to flesh out a business?

It depends. This is where the “risk capital” test might come into play. Again, the SEC does not use this, so if it’s a concern for someone, it should only be a concern at the state level (in the states that use it). Using the traditional Howey test, the answer would likely be “no, it’s not a security.” The Howey test involves an investment whereby the person expects a return based on the efforts of other people. Charging an enrollment fee would unlikely be considered an “investment contract” under Howey. Distributors would undoubtedly understand that the enrollment fee would not appreciate in value and entitle them to future earnings. However, if they live in a jurisdiction that goes a little farther and uses the risk capital test, the question then becomes: Is the enrollment fee being used to develop the business? If yes, what’s the stage of development at the time the enrollment fee was collected? If the business was in early stages at the time the fee was collected, was the payor induced by the business owner’s promise that a benefit of some kind, over and above the initial value, will accrue as a result of the enterprise? In my opinion, based on what I’ve read, the risk capital test is rarely a factor and when it is, the investments are usually substantial. The solution: be sure to offer something of value in exchange for the enrollment fee. Instead of treating it as an enrollment fee, treat it more like a sale. If there’s a beta version of the product or service, use the prelaunch phase to test it with early adopters. Throw in some free training, perhaps give them early access to future products or give them various discounts. And be sure to wait to pay commissions until the service is fleshed out. With this scenario, the moral of the story: do not sell the enrollment as an investment opportunity and add value in exchange for the money. And ideally, get the cash before you embark on the arduous journey.

Conclusion

It’s always a challenge for MLMs to get their businesses funded. Traditional angel investors are skeptical of the models and usually want a large chunk of equity in exchange of their investment. Due to these challenges to raise funds via traditional means, many executives rely on creative methods to get the cash they need. Some of these methods are legal, some are not. The methods discussed in this post are some of the most common that I see on a monthly basis. I hope you’ve found this article informative. I’d love to know your thoughts about all of this. What do you think?

Old School Marketing vs. Relationship Marketing

The market rewards people that add value daily, helping others win. As the CEO of Coca Cola recently said at the Chick-Fil-A Leadercast, “Customers are increasingly basing their decisions on a number of factors that never existed five years ago. They want more empowerment and they want to know that the company is socially responsible.” I agree! Marketing is changing to a more relationships-driven environment fueled by permission. The direct sales has been ahead of this curve for decades. The space is growing substantially and it’s only going to get better.

What are your thoughts?

Photo courtesy of @Kathy Sierra

Amazon White Paper: Why direct sales organizations should pay attention

There’s a rather lengthy white paper on the dominance of Amazon in the ecommerce space. It’s safe to say that Amazon is absolutely dominating e-commerce. In my opinion, Amazon’s dominance impacts direct sales organizations and the white paper below is worth studying. Due to Amazon’s amazing commerce platform, it’s easier than ever for a small business or an individual to create an online presence, market private labeled products to the public, house those products in one of Amazon’s warehouses, use Amazon’s shopping cart system to process orders and use Amazon’s logistics and fulfillment capabilities to ship those products. The moral of the story is simple: if a MLM is private labeling a product and does not have the exclusive rights to a formula, the time span between uniqueness and commodity is rapidly shrinking given the low barriers to entry. With MLMs today, it’s imperative to fortify operations with unique and proprietary offerings. When the MLM sales force no longer have unique offerings and instead have to compete on price against an individual leveraging Amazon’s service, Wal Mart or any other big box retailer, they’ll lose. Due to the speed at which people can knock-off products via private labeling, MLMs need to focus on proprietary.

As a MLM lawyer, I often encourage people to lock down proprietary rights early. This includes securing a patent or negotiating an exclusive arrangement from a vendor with a patent. The more fortified your business with exclusive rights, the better positioned your leaders will be in the marketplace. Enjoy the white paper below and tell me what you think..

Amazon White Paper

The End of Class Action Litigation in MLM?

This is an enormous Supreme Court decision for MLM companies. In a 5-4 decision, the Supreme Court held that consumers (distributors) can waive their right to participate in a class action lawsuit. The full article can be found here. The lawsuit was a case between AT&T and Concepcion. In the original lawsuit, Concepcion served as a class representative for consumers against AT&T over a nominal sum of money per consumer: $30. Clearly, $30 is not worth suing over; hence, the purpose behind the class action. But in the fine print in AT&T’s agreement there was a clause where the consumers waived their right to participate in a class action lawsuit and instead were required to arbitrate their disputes. Clever. And apparently enforceable.

This is nothing entirely new for MLM companies. However, it bolsters the argument that all disputes should occur in arbitration instead of aggregating mass numbers and filing a class action lawsuit. There’s a little bit of healthy criticism over the fairness of arbitration proceedings. As stated in the article, “Modern arbitration practices have been the target of watchdog group
Public Citizen for several years. Bills to create an Arbitration Fairness Act were filed in Congress in 2007 and 2010. In a release supporting the 2007 bill, organization president Joan Claybrook blasted the “take it or leave it” forced nature of the clause, the lack of oversight of the process, and supposed bias: ‘…(A)rbitration companies are beholden to big corporate players for repeat business, which creates a bias. They do not bite the hand that feeds them. For example, public data show that in the portfolio of one California arbitrator who ruled in 532 cases, 526 were in favor of business – a mere 1.14 percent for the ordinary consumer.'”

Brian Fitzpatrick, law professor from Vanderbilt, said if the ruling went in favor of AT&T, it would “end class-action litigation in America as we know it.” Given this recent ruling, it just got a lot easier for companies to skim a little here and there from consumers without much threat of consequences aside from a PR backlash. There’s not going to be single agreement now where there’s no class action waiver, which really takes power out of the hands of an aggrieved community, also referred to as a “class.” I have mixed thoughts on this one. What are your thoughts?

Ending the Hype: is it posible?

Travis Flaherty uncorked a great debate on his facebook page. Speaking of facebook, fan him up on the Travis Flaherty fan page here. In a facebook note, included below, he challenges people to end crazy hype when representing a network marketing opportunity. After reading his note, I immediately got flashbacks from when I was in the field several years ago. I’m guilty of making the same mistakes referenced by Travis in his article. In fact, I was WAAAAY worse! I never mentioned the company or its products. Instead, “I drove traffic to fortune 500 websites like Disney, Home Depot and Bass Pro Shops whereby they paid us for loyalty.” I left out the part that I only received a sliver of an affiliate kickback from those stores. When asked if selling was required, I said we simply built communities of people and drove revenue to product suppliers that paid us to transfer spend from our grocery budgets and buy products from our own business. I would say, “We’re a buyer’s club and they pay us for loyalty.”  Yep, I’m guilty of breaking the rules mentioned below. With the story I was weaving, you would’ve thought I was building the next Google. Instead, I was building Amway.

Note: I’m not suggesting how I promoted the Amway business was typical for all Amway distributors. I mention this illustration to make a point: I completely understand Travis’s call to end with hype. However, when there’s a focus on recruitment over product sales, or if the value proposition is out of line with comparables in the marketplace, it’s impossible to avoid hype and hyperbole because it takes a strong emotional pitch to overcome peoples’ gut instincts. When the value proposition is off, the glorified hype is inevitable.

The first impression when a prospect joins a business is crucial. It sets the framework for their entire experience. It’s the seed that influences their behavior going forward. When you’re in the field, education for the newbie is crucial. It’s important to inform them, at some point, they’re entering a sales and marketing business. Their function as a distributor is to move product volume, hence the word “distributor.” And companies, it’s important to publish and enforce standards designed to lead to proper positioning of your brand in the marketplace so you can properly educate and, if need be, weed out the people misrepresenting the particulars of your business. Yes, there are companies out there that are willfully (and blissfully) ignorant of how their product or service is being positioned in the marketplace. But in the end, when a business fails to deliver on some of the basic elements presented in the leaders’ presentations, it burns down quick.

Travis’s note is below.

I thought about abridging it but there’s too many good points. It’s included in full below. What are your thoughts? Do you think it’s realistic to expect hype to end?

You are entering a no Spin Zone…
Warning: This article is probably the most controversial article I have written. By continuing to read on, you run the risk of being offended. If this is you, then it is likely you need to hear this information! My intent in writing this is to raise some clarity on what it means to be a TRUE ‘Network Marketing Professional’. It’s important to point out much of what I will be talking about, the examples I will be giving, I HAVE DONE PERSONALLY! As leaders, we are eager to share our victories – but forget there is even more wisdom in sharing our mistakes and past failures. It is my hope that my trial and error can help you to avoid some of the same pitfalls I’ve fallen in over the years.

There is a serious issue running rampant in Network Marketing. In fact, I believe this issue is so big – it threatens the very livelihood of our industry. Unless we, as leaders, take a stand against this problem our profession will never be taken seriously. The issue I am referring to is “The Spin” that goes on in Network Marketing. Others might describe it as “Hype”. In other words, I am referring to saying or representing something in a manner, in which the intent is to have someone assume something, that otherwise would not be true.

Allow me to provide some specific examples of what I am referring to. (Again, picking on myself for a moment) I was recently traveling internationally with my good friend and mentor, Jef Welch. We were in a cab together on our way to a business briefing. As Networkers, we naturally sparked a conversation with the cab driver by asking the normal questions; “How long have you been driving a cab?” “Do you enjoy what you do?” etc. We had a very pleasant conversation, during the drive. When we were exiting the cab I was prompted to invite the cabby to the event we would be speaking at later that evening. (Here’s where my MLM training kicked in) I started with a quick look at my watch – to suggest I was in a hurry. I complimented the driver, I had already decided on an ‘indirect approach’ since I did not have a great report with the driver. “So let me ask you a question; WHO DO YOU KNOW that might be interested in a potential six figure income opportunity, working from home?” Of course it prompted the real question I was looking for from the driver, “What is it?” he replied. I grinned with confidence knowing that I had just gained posture in the conversation. (I thought to myself, Eric Worre would be so proud!) Then I made the invite, “If I were able to get you ticket, to a very special event on creating wealth, hosted by some very powerful people might I add – would you be able to attend?” And then I continued, “Now I’m not saying I can get you a ticket, as they are sold out. But IF I could get you a ticket, for free, would you be able to make it this evening?” Now, most reading this may not see an issue with my approach. In fact, I thought it was excellent at the time. I was doing exactly what I had been trained to do. My Mentors had always taught me when inviting to build huge audacious value.

The reality is, if you really break down what I said, I suggested that this was a ticketed event. I suggested there was a fee to attend and I implied not everyone could attend – that in some way this was exclusive. Now, I know you could argue what we were to speak on was of value, that it was exclusive or ‘invite only’ – which could justify the word “ticketed”. Believe me I tried, when I was called out on this. Later that evening, Jef and I had a discussion about leadership and how important it is to have integrity at the top. I agreed. He then surprisingly brought up my approach earlier in the day, as an example of the “Spinning” that goes on in NM.

At first I was defensive. “I did exactly what I had been taught”, I thought to myself. However, after spending 15 minutes trying to defend my position, I decided to really listen to what he was saying….And he was right! Jef Welch called me out on this and I want to thank him for doing it because it’s helped me raise my game to the next level.

“Spinning” and “Hype” have been around NM since its origination. The only difference today is it’s highly perpetuated and amplified by Social Media. Another example I often see is when people post things like “500 people just joined my business in the past 7 days”, etc. This often happens in a Binary compensation plan because it allows you to build hype around fear of loss. “Get in now or else you’re missing out!” The problem is the people who want you to THINK they’re making a fortune, aren’t! What they’re not telling you is they are part of a power leg that is growing (largely because of the people above and below them doing the same thing). More often than not, they only have a few people on their inside leg, dictating their actual pay.

How about this one: “I am looking for my next 3 people to teach how to make six figures this year.” I see this all the time on Facebook and Twitter. The sentence SUGGESTS that you have already done this in the past – when in fact 90% of the people posting things like this have not! When I started in MLM, some of the worst advice I was ever given was “Fake it till you make it”. This is still very prominent in the industry today.

Now I know many of you reading this are going to say, “Well technically what I am saying is the truth, if you really look at what I am saying”. And I hear you…The question I would ask is not, what are you saying,” technically”; it’s, what are you leading people to believe or assume? Building your business upon “SPIN” and “Hype” is likened to building a foundation on shaky ground. It won’t last! You will continue to attract the bottom feeders in your business, the people who are looking to ‘get rich quick’, or catch the next free ride. My friend Jef was right; you must have INTEGRITY AT THE TOP if you want to build something that lasts. And isn’t that why we all entered into this industry – To create a long term, residual income for our family?

In closing, if you want to be a part of raising the bar in this industry, if you want to proudly call yourself a Network Marketing Professional – then it’s time to step up and declare a “No Spin Zone!” The only true way to grow an organization is to focus on what you have to offer from a personal standpoint, a systematic standpoint and most importantly – A leadership standpoint! The moment people join your team because of what YOU have to offer, when you no longer have to rely on “Spinning” to recruit, YOU KNOW YOU’VE ARRIVED!

In the spirit of success,
Travis A. Flaherty