I recently fielded a phone call from a business owner who asked me the following question: Does my business model qualify as a multi-level marketing company? It’s a good question whose answer invokes a variety of possible legal implications.
THE MLM LEXICON
With no single authority providing some sort of precedential definition of “MLM,” the best way of boiling the concept down to its essential elements is through the lens of different authorities and sources.
The original definition of a MLM arose from the 1979 Amway decision, as the FTC defined MLM as,
A business model in which a company distributes products through a network of distributors who earn income from their own retail sales of product and from the retail sales made by distributors’ direct and indirect recruits.
Viewed through the proper context, this original definition is outdated. In the 1970s, Amway shipped inventory to “Directs.” Directs were charged with ordering product on behalf of their entire downlines and distributing such product out (hence the term “distributors”). With today’s current sales climate of direct-fulfillment, in which parcels of inventory are drop shipped to individual consumers, companies no longer ship inventory “through a network of distributors.” Instead, they utilize the direct fulfillment method to ship individual orders to individual distributors and customers.
On its website, the FTC defines MLM as
In multilevel or network marketing, individuals sell products to the public — often by word of mouth and direct sales. Typically, distributors earn commissions, not only for their own sales, but also for sales made by the people they recruit.
While the FTC’s explanation isn’t bad, it’s overly broad. Rather, the best definition, in my opinion, arises out of the FTC’s case against BurnLounge. In the BurnLounge Final Order, the court put forth an excellent explanation of a Multi-Level Marketing Program:
Any marketing program in which participants pay money to the program promoter in return for which the participants obtain the right to: (a) recruit additional participants, or 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; (b) sell goods or services; and (c) receive compensation, in whole or in part, based upon the sales of those in the participants downline, tree, cooperative, income center or similar program grouping.
The BurnLounge Order clearly articulates the core characteristics of a MLM: (1) participants’ ability to market products/services to consumers both inside and outside of the genealogy; (2) the ability for these participants to derive income from their direct sales and the sales generated by their downline (recruits); and (3) payment derived from a compensation plan that consists of two or more generations of incentives on indirect recruits. At its most basic, the MLM equation boils down to this:
Incentive to sell + incentive to recruit + multi-tiered compensation = MLM
As you can see, the most recent definitions say nothing about whether product is “distributed” through distributors. There’s a theory floating out there that companies are NOT technically MLMs merely because they ship product directly to distributors and customers. As the definitions above make clear, the act of “selling” plus the ability to recruit…those elements equate to the existence of a MLM. If I were to boil the ocean, it boils down to multiple levels of compensation, not multiple levels of distribution. If anyone in the program can recruit and earn an override on the sales volume, it’s a MLM.
YOUR BUSINESS FITS THE MLM BILL, NOW WHAT?
The biggest implication for being a MLM is the compliance burden of managing and training a sales force of amateurs. At the core of Network Marketing, there’s the ability for ANYONE to get involved and make money. While this is one of our industry’s many strengths, it’s also a weakness. The sobering reality is this — for better or for worse, participants collectively form the speakerphone by which a company broadcasts itself to the world. When participants can wear a company’s flag and expand the sales force via recruitment, it triggers some significant burdens.
The next significant implication of being a MLM is the risk of pyramiding. When people are incentivized to sell AND recruit, it’s vital for MLMs to ensure that the two incentives are properly balanced. Balance is achieved from the top down. While a lot of companies today want to roll the field under the bus when times get tough and play the “we-can’t-control-every-knuckle-head-in-our-business” game, it’s entirely up to the company to structure the incentives to drive the right behaviors.
Regarding state law, there are several states that require specific filings for all MLMs. Those are easily addressed by an experienced attorney.
Since we frequently get this question, we thought it made sense to lay it all out there and provide some help. Instead of being cute with the definition of “MLM,” companies that fit the mold need to embrace reality and do their very best to be responsible citizens in the MLM industry. When MLM companies proclaim “we’re not a MLM,” in most cases, they’re doing so because they feel it reduces their risk. This is not the case at all. There’s great power in turning over the expansion efforts to independent contractors. And as the saying goes, with great power comes great responsibility. Since the field is primarily comprised of consumers, companies need to take strong measures to ensure those consumers, and the people they’re recruiting, are protected.
As an owner comes to realize that their business fits the MLM mold, understanding the scope of risk should be priority #1.
What do you think? Any surprises here?