The MLM Startup Guide
“Is it legal for me, my partners, or management to have positions in the genealogy?” That is a common question I’m asked by owners of start-up multilevel marketing businesses. The straightforward answer is, yes – it is legal. There’s no law prohibiting it. However, as with many MLM legal issues, the more appropriate question is: “Is it wise for me, my partners, or management to have positions in the genealogy?” It’s amazing how changing one word can have such a dramatic impact on the answer to the question, for the wisdom of owners or employees holding genealogy positions, at least without proper advance planning, can be highly questionable.
Let’s list the reasons why MLM company owners typically want to hold a genealogy position: Money. That’s pretty much it.
Now let’s identify the reasons why it may not be wise for owners to hold a genealogy position:
The financial benefit for owners to hold a genealogy position is a fallacy. When the company owners take genealogy positions, it is normally at the top of the multilevel genealogy tree. In this case, they are simply siphoning funds that would go to the company’s bottom line.
Owners holding genealogy positions can inhibit an IPO. Not only is the cash benefit associated with management owning a genealogy position a fallacy, it will create an obstacle to a public offering if the MLM company wishes to do an IPO because an underwriter will view owners’ commissions as properly belonging to the company. Therefore, they should expect to forfeit their position before an IPO should the company take that path.
Minority shareholder rights may be violated. It is not unusual for the principal shareholders of a MLM company reserve genealogy positions for themselves, but not to reserve positions for minority shareholders. Because majority shareholders generally have a fiduciary obligation to the minority shareholders, they are exposed to a claim that, by siphoning company profits through their top-tier positions in the genealogy, they are breaching their fiduciary obligation to the minority shareholders.
You may be unwittingly selling a security. If you provide an investor with a genealogy position in exchange for their investment in the company, but the investor is not to play a meaningful role in the management of the company, in most cases the transaction will constitute the sale of an investment contract security. The transaction is then subject to myriad complex state or federal securities laws. Failure to abide by these laws exposes the promoter to civil and potentially criminal securities fraud charges.
Ownership of genealogy positions by owners can lead to an inequitable distribution of income. The owners who most often desire a position in the genealogy are: (a) those who receive the very top positions therefore benefitting from the majority of downline volume; and (b) those who are in the field and thus are in a position to build a business. That leaves out other owners who, although critical to the success of the business, are not in a position to build the MLM business. For example, a partner who is in charge office-bound functions such as Information Systems is certainly critical to the success of the business. However, they have little opportunity to build a business because they are not in the field. This leads to an inequitable distribution of income among management which can result in animosity and disputes unless the income of office-bound personnel is balanced through other means.
Ownership of genealogy positions can lead to conflicts of interest. Management should act in the best interest of the company. However, ownership of a genealogy position can create in a conflict of interest when the financial interest of management in maximizing commissions gets in the way of acting in the best interest of the company. For example, I once had a case in which a company shareholder in a multilevel marketing company held a position in the genealogy. He also served as vice-president of sales. His downline was strong in Western States, and consequently, that is where he spent most of his time – after all, that’s where the money was. However, the company needed him to develop other states, and he was fired when he refused to work in other states, but because he was also a shareholder, the separation was incomplete and a heated lawsuit ensued.
Termination of a business relationship is made more difficult if management holds a genealogy position. If an owner or member of management is fired, or if a shareholder is ousted from the company, their official corporate capacity is ended. However, if they hold a genealogy position, they remain infused in the field where disgruntled former personnel can do great damage.
Genealogy positions held by management cloud the independent contractor relationship. Independent distributors for a multilevel marketing or network marketing company are generally considered independent contractors. The company does not withhold taxes, unemployment security, or workers compensation from their commissions, and under most circumstances, the company is not responsible for the torts of independent contractors. However, management personnel are typically employees of the company. Employment withholdings are taken from their paychecks, and the company is responsible for the torts of its employees. With regard to management personnel holding a genealogy position and working a business, there is little chance to make a meaningful separation between an individual’s employment and independent contractor status; the company should anticipate that the management personnel will be treated as employees in all respects.
The challenges associated with management holding a position in the genealogy can be overcome with proper planning and execution. Unfortunately, because startup MLMs normally don’t recognize the issues, planning and execution in this area are often lacking. So if you are starting an MLM and are considering taking a position in the genealogy, you should first carefully consider the points addressed above. If after careful consideration you elect to move forward with owners and/or management holding genealogy positions, ensure that you have your legal strategy in effect before agreements are reached or promises made regarding genealogy position distribution so these challenges don’t impede the business.