Multi-Level Marketing and Franchising: Look Out Franchisees

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Multi-level marketing (MLM) is a strategic distribution method where the vendor or the manufacturer builds a network of distributors to sell their products or services, without any substantial investment. This may be different from franchising in terms of definition, but in some forms of contracts franchising directly coincides with the idea of multi-level marketing. this form of distribution relies upon the distributors and they are paid commissions on the basis of the sale. These distributors are encouraged to recruit more lowline distributors to carry on the process. The products that the distributors procure from the manufacturers may be for personal use or for resale to third parties, and that’s how the network is built.

Franchising and MLM are similar in terms of when there is a resale of the products or services, the existence of a network structure that was mentioned above, and/or the provision of administrative support. Meanwhile, when the franchises offer the distributors or franchisees a bunch of industrial and Intellectual Property (IP) Rights, multi-level marketing does not necessarily provide any such promises. This is a major differentiation between a franchising unit and a multi-level marketing business module.

In most cases, there is a thin line between the two, yet it’s not difficult to distinguish between franchising and MLM. However, there is a smart wordplay of common franchise terms that are actively used in the contractual proposals which direct attention towards franchising, and that leaves a fragile line between the two concepts.

To avoid such misinterpretations, a wannabee franchisee should carefully review the terms of the proposed relationship. This is where the Franchise Disclosure Document (FDD), and other critical contractual proposals need to be scrutinized word to word.

Key Elements that Should be present in the pre-contractual disclosure:

involvement of the franchisor, nature of the products or services that would give the franchisee a fair competitive advantage,
the franchisee should be provided with the supplies to distribute,
the franchisor should extend assistance services to the franchisee,
The registration details of the franchisor’s trademark should be verified and indicated in the franchise contract, and
The franchisor should propose to grant industrial and IP rights to the franchisee.

The above-mentioned key elements should be always included in a franchise agreement, but are at most times completely avoided in the case of MLM.

Multi-level marketing is occasionally promoted as franchising. One such unlawful plan, in which a supposedly energy-saving device was used as a pretext for recruiting to a network and demanding substantial entry fees, ended in 2009 with the promoters being convicted of criminal conspiracy to defraud.

Hence, prospective franchisees must be alert to fraudulent MLM agreements that are presented as franchise agreements, as participation may have consequences in criminal law.

Federal Trade Commission prohibits fraudulent multi-level marketing – that is, the promotion and organization of sales activities in which the primary economic incentive for the participants is the recruitment of new network members, and in which the right to recruit persons – in return for payment – is transferred continuously on payment of consideration. Violation of this prohibition carries criminal penalties.