Download firm BurnLounge Inc. of Los Angeles has quickly become one of the music industry’s hottest acts, ignited by an Internet version of multi-level marketing.

In less than a year, it has caught on with such industry heavyweights as deejay Rick Dees, Justin Timberlake and Kanye West, and attracted such advertisers as Cadillac and Nokia.

Moreover, it has enlisted an online army of more than 40,000 retailers known as “burn team members.” They sell music for downloads, and the retailers share commissions with those who enlisted them.

Founded by Chief Executive Alex Arnold, Chief Operating Officer Ryan Dadd and Chief Creative Officer Stephen Murray, the company combines iTunes-type music downloads and eBay-style retailing with traditional multi-level marketing.

But could BurnLounge’s business model be the cover of an old tune: the pyramid scheme?

BurnLounge’s Arnold bristled at the suggestion that his company’s multilevel marketing he prefers the term “concentric sales” could tip into anything illegal.

“I would call it more of affiliate marketing meets fan-to-fan promotion.”

Multilevel marketing can be tricky terrain. Even successful mainstream multilevel marketing firms, such as Herbalife International Inc., have wound up in legal hot water by not managing their operation correctly.

In order for a multilevel marketing model not to be considered a pyramid scheme, the majority of the proceeds from sales must go to the retailers, not to those who recruited them.

The deal

The business works like this:

Users create pages where they post and sell artists’ music of their choosing for buyers to download. Downloads of a song typically go for 99 cents.

Each participating artist signs a non-exclusive, one-year license agreement with BurnLounge and gets between 50 percent and 70 percent of the revenue generated by sales of their songs.

Of the remainder, BurnLounge corporate takes 60 percent while the retailer who sold the song gets 40 percent. However, the retailer must give 20 percent of his take to the one who recruited him. The recruiter must pay a percentage of his take to the one who recruited him, and so forth.

In addition, each retailer gets a $50 bonus for each new retailer recruited; all retailers are part of a “Burn Team,” directly tied to the person who recruited them.

“You get rewarded for your team’s sales. Music is a fairly low margin product, so you are earning pennies and cents a little bit of a lot of people,” Arnold said. “That’s the beauty of it; nobody makes that much money on a single album sale.”

BurnLounge is not a pyramid scheme because financial success for the retailers is not solely dependent on recruiting others. A pyramid scheme relies on enrolling new sales people in order to make money.

However, there are elements that resemble those traditionally associated with pyramid schemes, including recruitment presentations in hotels and special events designed to entice potential sellers.

But Arnold pointed out that rather than a commodity or a line of products, BurnLounge sells various music that’s highly segmented and user-specific. Small, independent bands are the linchpin of BurnLounge’s content library.

In fact, the increased exposure and payment for the legal downloads is luring hordes of garage bands and their followers. BurnLounge already has almost 2 million tracks posted for purchase. Every user can configure his download page to promote bands of his choice, so the more friends and fans who sign up, the bigger his potential audience.

True believers

Not surprisingly, most of those involved with BurnLounge are true believers.

Robby Welles, a former real estate agent who now hosts BurnLounge recruitment seminars at hotels and other rented spaces, started an online download store in January.

Welles said he was skeptical when a friend asked him to attend a BurnLounge presentation, and that he resisted multiple invitations. Finally, in return for dinner and drinks, he agreed to go.

“My first reaction was, ‘Thanks, man, but I don’t have time for anything like that’,” Welles said.

After the presentation, Welles said he was impressed and signed up right away. He said that within three months he had left his job to focus on his stores and now has more than 4,000 members on his two “burn teams.”

“I heard who was involved and I felt my reputation was no longer on the line, that it was legit,” Welles said. “The company is changing the direct sales industry because it’s making it cool and fun. The money’s good and it will just keep getting better.”

Arnold has a background in direct sales and marketing with Lexxes International, a cosmetics sales firm, and Excel Communications, a telcom firm. He started developing the BurnLounge plan with Dadd and Murray in 2004.

“I had been very successful with the distribution of other products and thought, why don’t we do download sales as communities?” Arnold asked. “As (retailers) build their communities, they make a percentage. It’s sharing the profits.”

The group incorporated and, with about 50 employees, it launched its beta site last year. In June, BurnLounge officially launched at its location in Sherman Oaks.

It gained legitimacy quickly through connections with major industry names. Performers Justin Timberlake and Kanye West have download pages and longtime L.A. deejay Rick Dees was an angel investor in the company.

“He placed a significant amount of capital early on. Some very, very smart money,” Arnold said.

Venice Beach-based Benevolent Partners LP, a hedge fund, is a major backer and there are a handful of individual investors.

Arnold said BurnLounge hopes to expand its offerings to video, audio books, ring tones and other short-form content, as well as merchandise. Music, however, is clearly the engine pulling the train for BurnLounge and the download industry.

According to the International Federation of the Phonographic Industry’s 2006 Digital Music Report, revenues from digital sales jumped from $400 million in 2004 to more than $1 billion last year, with single tracks downloads up from 156 million to 470 million.

Analyst Rob Enderle of the Enderle Group said staying profitable might be a challenge for BurnLounge. Multi-level marketing is typically most effective with premium or high-end product sales, which may not apply to music downloads, he said.

“Those (sales) commissions have to come out of something,” Enderle said. “But with music downloads you’re talking about cents, so you’ve got to move a lot to make any money, and usually you will see a couple guys up at the top making a lot of money, and a lot of folks at the bottom doing a lot of work.” “Viral multi-level marketing certainly has a lot of potential, but there’s not a whole lot of margin in that space and there’s really no such thing as premium music.”