Licensing vs. Franchising
Both licensing and franchising are legal relationships, that must follow laws in order to be used to develop and expand your business. Failing to follow these requirements can open you up to the possibility of legal action by those you enter into agreements with and even worse with the government and regulatory agencies.
What is a License?
A license is a legal relationship where one party, the Licensor, grants the other party, the Licensee, the right to use and benefit from either a trademark, technology or other rights of the Licensor. A license can include the use of one of these items for a limited purpose, a specific offering (paying for a computer program like Microsoft Office), or providing the formula or design to another for them to build or create the product. A license is formalized by a legal agreement between the parties that defines the relationship and outlines the terms permitting the use of the asset.
What is Franchising?
A franchise is a legal relationship where one party, the Franchisor, grants the other party, the Franchisee, the right to use and benefit from a trademark and a business system in exchange for a fee. In a franchise relationship there is more control exercised by the Franchisor on how these items can be used by the Franchisee in the operation of the business. The goal is for the Franchisee to run their business in an identical nature as the Franchisor, think McDonald’s, Burger King, T-Mobile.
Three elements that establish a franchise relationship:
- The license to use the name and/or trademark of the business;
- The use of a system. The franchise agreement will outline how the Franchisee will use the Franchisor’s system; i.e. following a certain rules and guidelines for the establishment and operation of an identical business.
- The payment of a fee, which is called a franchise fee. The franchisee will continue to pay a fee called a royalty fee for the continued use of the licensed name and the system.
Having a franchise means that you must follow the Federal Trade Commission (FTC) Guidelines to have a Franchise Disclosure Document (FDD). Additionally, some states requirement that the Franchisor file a copy of the FDD with them and answer questions concerning the offering of the franchise in their state.
Are there alternatives to franchising?
Although franchising is a popular way to expand a business, there are alternatives that may be better suited to your marketing and expansion goals.
Alternatives to franchising include:
- Distributorships: In a distributorship, a distributor buys products from a supplier, and then sells those products to purchasers. Distributors may be permitted to have contracts with other suppliers and may operate independently from the supplier. The supplier will not usually require the distributor to pay an initial fee for the right to distribute the product, or to pay a royalty: the supplier’s income is made from sales of products. The supplier will not have the right to prescribe how the distributor operates its business.
- Business opportunities: Business opportunities are less structured than franchises. They are arrangements where a seller provides goods or services to enable the buyer to start a business, and where the seller represents that: (i) the buyer will earn more than the cost of the business; (ii) the seller will buy back all or part of the buyer’s product; (iii) the seller will provide or help find locations; (iv) the seller will refund the initial payment; or (v) the seller will provide a marketing or operating plan. Business opportunities are governed by the Franchise Rule and state business opportunity laws.
BCC can help determine if franchising or an alternative is the right choice for you.
Learn More About Franchise Law
Franchise law can be complicated and there are common pitfalls that can escalate if ignored or not addressed effectively.