In Part 1 of the crowdfunding series, I discussed the rise of the crowdfunding phenomenon and Title III’s recent enactment under the JOBS Act. While Title III may appear to be an attractive avenue of capital fundraising for entrepreneurs and startups, founders of a network marketing company may find it a boardwalk littered with more stops than gos. As for crowdfunding as a MLM product service or offering, in my opinion, its a chance to go directly to jail.
TITLE III CROWDFUNDING AS WAY FOR MLMs TO RAISE CAPITAL
If you remember, the benefits of a Company looking to use Title III appear numerous. Title III provides the ability to raise up to $1 million without having to deal with burdensome SEC requirements. For an MLM looking for startup funding, what’s not to like? Well . . . er, money for one. The logic goes something like this: you have to have money if you want to raise money.
When a distributor is terminated by his or her MLM company, he or she may claim breach of contract and seek recovery of his or her past and future commissions. After all, the distributor may have worked for months or years to build up his or her downline only to have its income stream summarily stopped and taken by the company.
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The term “crowdfunding” has been thrown around a lot over the past several years. But what does “crowdfunding” really mean? And how does crowdfunding, particularly the recent enactment of rules from Title III of the JOBS Act, relate to network marketing?
At its most basic, crowdfunding is the pooling of financial contributions via the internet for a project or enterprise. The ubiquitous nature of the term has led to a great deal of confusion. However, “crowdfunding” is most easily understood as an umbrella term referring to three different models for raising capital: donation-based, rewards-based, and equity-based. Before discussing the challenges more commonly associated with equity-based donations, let’s cover the more commonly known types of crowdfunding.
DONATION AND REWARD-BASED CROWDFUNDING
Congressman Marsha Blackburn, House Representative of the 7th District of Tennessee, has proposed the Anti-Pyramid Bill Federal that aims to clarify the differences between pyramid schemes and legitimate network marketing companies. If you’re connected to the network marketing industry, whether as a distributor, executive, vendor or owner, the importance of this bill (or a modified version of this bill) is vitally important.
The Need for Clarity
As many of my readers know, I have aggressively advocated for almost a decade for the need to create cleaner guidelines in the industry. The “ocean of gray” that has separated legitimate direct selling from pyramid schemes has predictably led to some very serious challenges. As I accurately predicted in my first e-book titled “Saving the industry by defining the gray,” the fuzzy lines that distinguish legitimate and illegitimate network marketing has greatly contributed to today’s problems. In an environment with ample wiggle room, pyramid schemes can operate under the guise of legitimate network marketing. Zeek Rewards, notable ponzi scheme, did this better than all others. The veneer of legitimacy offered by legitimate network marketing allowed Zeek to amass tremendous influence and inflict significant harm. This, in turn, affects the entire profession.
Most Multilevel Marketing companies claim that their list of distributors is a proprietary asset of the company. When a departing distributor uses the list to solicit other distributors to follow him or her to a new company, the MLM company cries foul ball. Indeed, many MLM companies include in their Policies & Procedures provisions acknowledging the proprietary nature of the company’s distributor list (i.e. genealogy) and providing restrictions allowing use only in conjunction with the company’s business.
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Wellman & Warren, LLP has, once again, successfully defended a Federal Trade Commission (FTC) investigation of a Multi-Level Marketing company. Due to the private and confidential nature of the investigation, Wellman & Warren is not able to disclose the names of parties involved in the investigation. The FTC’s investigation centered around the methods in which the company paid commissions to their distributors as well as various income claims made by the company and their distributors.
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Out of all of the topics covered in MLM law, there is not a single topic more obfuscated and misinterpreted than the 70% Rule. This rule has been purposefully screwed up by MLM critics in an effort to craft a narrative that suits their agenda. Candidly, I’m shocked that neither myself nor my peers have addressed this sooner. The rule is incredibly easy to understand ONCE YOU UNDERSTAND THE HISTORY.
The Origins of the Seventy Percent Rule
The Seventy Percent Rule was one of the “Amway Safeguards” that the court highlighted in 1979 when it found that Amway was NOT a pyramid scheme. The summary of the rule: In order to qualify for downline bonuses, Distributors had to move 70% of their existing inventories to customers OR distributors. The spirit of the rule is designed to ensure that Distributors were not “garage qualifying” and sitting on inventory. The inventory had to MOVE to other people.