When licensing or franchising a brand, both business models will allow a third party to profit from the use of intellectual property for a fee. However, while a franchise allows access to the brand’s trademarks, business model, and operations, a license is a brand cooperation that limits the use of a specific trademark.
In a franchise, a franchisee is subject to the franchisor’s guidelines on operating their business. With a license, the licensor does not interfere with how the licensee operates their business, only with how they can use the intellectual property.
Licenses work best for product-based companies, while franchises fit best for service-based businesses.
A franchise’s parent company reputation will depend on the franchisees’ performance, however, licensors typically do not have a close link to licensees, for the latter continues working as a separate entity.
The objective of franchises is to expand and improve brand awareness at a low cost, while the sale of licenses aims to grow the presence of a product.
Franchises and licenses cannot be used interchangeably, each model offers different legal and operational restrictions and benefits that work best for specific businesses and objectives. In this article, you will learn the differences between franchises and licenses, each’s pros and cons, and which would help you attain your business objectives. Always count on the advice of a franchise attorney to ensure you are making the best decisions for your business at the minimum risk.
What is franchising?
Franchising is a business expansion model that occurs when an existing brand sells the rights of profiting from its trademark and products in exchange for payment.
In this business agreement, the franchisor, which is the owner of the company, will allow access to its intellectual property and operations for the franchisee to open a separate branch that will replicate this business model.
Franchisors and franchisees have different roles. While franchisors are responsible for providing a replicable business model, knowledge, and support, franchisees bear the cost of opening the branch in a determined territory and paying the required fees.
As specified in the franchise agreement, a franchisee will benefit from the use of the intellectual property and have the franchisor’s support for a determined duration. By paying an initial fee and ongoing royalties, the franchisee will be able to manage their own location, always abiding by the guidelines of the franchisor.
The main objective of franchising a business is expanding its market share and operations at a low cost through independently operated businesses.
At the federal level, a business that meets the following three elements is legally considered a franchise,
The business requires a fee from a third party
The fee payment is in exchange for the use of a trademark
The original owner has significant control in the operation of the business
If a business satisfies these three requirements, it is now subject to the Franchise Rule, established by the Federal Trade Commission, and must also comply with state laws.
When it comes to franchising, the first thing that surely comes to your mind is restaurant franchises. However, almost any kind of business can enter this category. Among some of the businesses that can be franchised are fast-food chains, retailers, cleaning services, and fitness centers.
Some of the most famous franchise businesses include:
- Pizza hut
- Orangetheory Fitness
- Burger King
- Marriot International
- The UPS Store
With more than 5,100 locations in the United States, The UPS Store is a postal services company that offers franchising opportunities to entrepreneurs. After 40 years of experience, they have expanded their network of shipping, postal, and business services in the country. A business owner is allowed to use the UPS trademarks and has access to its business model and operating procedures in exchange for a fee and royalties.
What is licensing?
Licensing is a business agreement in which a company authorizes a third party to use registered trademarks, technology, or other intellectual property assets for a specific purpose.
A licensor, who provides the right to use the IP, will specify the restrictions regarding the use or manufacture of the licensed asset. However, the latter does not own the licensee’s business or any part of it and therefore does not have control over its operations.
Licensing a product can have several objectives, such as increasing market share and brand awareness, developing client loyalty, and generating revenue.
A licensing agreement will specify the following:
Licensed asset: Includes a description of what is to be licensed
Exclusivity: Whether there can only be one licensee or if several people can profit from the use of the asset
Duration: For how long the licensing agreement has validity
Location: Defines where the product can be distributed or any geographical restrictions
Payment: The structure of the royalty payments, which can be a one-time fee, ongoing royalties, or a percentage of the profit made from the use of the license.
Confidentiality clause: Prohibits parties from disclosing sensitive information
Some pieces of intellectual property that can be licensed include songs, artwork, patents, technology, and logos. The following are examples of companies that extend licensing agreements:
- Calvin Klein
- DC Comics
- Harry Potter
An example of a license includes Disney, which allows the McDonald’s franchise to use its characters to include them as toys in the Happy Meal. While Disney dictates how their artwork will be used, they do not interfere in McDonald’s business operations.
Starbucks is another example of licensing which can be easily confused by a franchise. While they have the right to sell the same products and make use of Starbucks\’ trademarks, each location has independent control of its business and is not required to follow the brand’s business plan.
Differences between licensing and franchising
If you are planning to expand your business operations, it’s key that you understand the differences between licensing and franchising, since each is going to bring financial, managerial, and legal implications you must consider first.
Here is an in-depth explanation of the main differences between franchises and licensing agreements.
In a business franchise, the branch essentially belongs to the franchisor, while the franchisee benefits from it for a fee.
On the other side, when licensing a brand, the licensee only pays for the use of a specific product, but the rest of the business remains intact by the licensor
A franchise agreement will give the franchisee access to a broad number of assets, including trademarks, logos, trade secrets, the operating manual, the business model, and more.
A license will only authorize the use of specific assets under certain conditions and does not provide access to any knowledge regarding the licensor’s business operations.
In a franchise agreement, a franchisor will determine the guidelines the franchisee must abide by, regarding the use of trademarks, territorial area, suppliers, equipment, dress code, and operating procedures. A franchisor will ensure every branch holds the same essence, that it is easily identifiable as part of the business, and get involved in key decisions regarding marketing strategies and service quality.
Conversely, a licensor has no power over the licensee’s business decisions and can only set restrictions related to the use of the protected trademarks in question.
Type of business
A business that enters a licensing agreement can offer products or services but is mostly related to products. The simple fact of adding a logo to a product can notably increase its sales, as is the case of Calvin Klein, who does not manufacture underwear, but licenses clothing companies to portray their brand on their products.
On the other hand, franchises deal only with service-based companies, such as restaurants. The need to have access to meal-preparing procedures, the business model, and suppliers, will mostly push a business owner to enter a franchise business model.
Any franchise must comply with franchise laws, and abide by:
- Federal franchise rule
- State franchise rule
- Federal Trade Commission
- Contract Law
Depending on the state a franchise opportunity will be offered in, a franchisor must also register their FDD before selling their franchise and update their state registrations annually.
A licensing agreement is only governed by general contract law and is not as heavily regulated as franchises.
One of the most attractive features of franchises is they provide franchisees assistance for as long as the duration of the agreement. A franchisee can benefit from the franchisor’s business knowledge, receive training, and have the tools for better management of their business. In general terms, franchisors and franchisees have a strong and mutually beneficial business relationship.
License agreements, on the contrary, typically do not aim to build a strong business relationship and do not provide any kind of support for franchisees.
License agreements are more economic than franchises in the sense that fees are more attainable and scarce.
To buy a franchise, you will have to at least pay an initial fee, advertising or brand fund fees, training fees, and ongoing royalties.
Licenses usually involve only a one-time payment.
Among some of the procedures a franchisor needs to do to buy a franchise, they need to provide a Franchise Disclosure Document, sign a Franchise Agreement, collect payment, and provide training and ongoing support for the franchisee.
When licensing, a licensor is only required to a one-time transfer of property or rights.
Franchising vs. Licensing: Pros and Cons
These business expansion models offer different advantages and disadvantages for both the providers of the intellectual property and their users. Rather than opting for the cheapest or easiest option, assess which alternative will help best to meet your business objectives in the long term.
Read a complete guide on the advantages and disadvantages of franchising.
Advantages of a license
As a licensee, you can freely run your business without the undesired intervention of the licensor. You will continue to make crucial decisions and operate your business as you please. The only restriction you will have will be regarding the use of the protected trademark.
License agreements also give more space to negotiations, contrary to franchise agreements, for licensees can obtain better deals after discussing more favorable terms.
As a licensor, you are not required to supervise the business to which you provided the license, nor provide them with any type of training or knowledge.
To license an asset, both parties will typically only need to sign a license agreement that will establish the terms and conditions of their business relationship. Compared to franchising, which involves complying with different laws, creating training programs, and providing ongoing assistance to the franchisee, licensing a trademark is relatively easy.
As mentioned, licensing will involve little investment. Since a licensing agreement is not as complex, they are less expensive to create than franchise agreements. Other than the fee for the contract attorney who will draft and negotiate the licensing agreement, neither party is likely to worry about other payments, such as those required to establish a new location or open new distribution networks.
Increased brand value
A small or unpopular company can use the support of an established company by selling products that are already positioned in the market. Licensing offers less risk because you are working with a company that has a built-in customer base.
Disadvantages of licensing
Lack of support
A licensee typically will not receive any kind of assistance that could help them get a better sense of the management of the business.
Since licensing agreements are easier to handle and are not as heavily restricted, a licensee will possibly face many competitors selling similar products in the same territory.
As a licensor, you do not have a lot of control over how licensees handle your intellectual property. If the products they offer on behalf of your brand do not have an acceptable quality, the reputation of your brand is compromised.
Lack of uniformity
With a licensing agreement, a licensor cannot expect their brand to follow a standard, so it will be difficult for a brand to maintain consistency.
Advantages of franchises
For the original owners of a business, franchising is a low-cost expansion strategy that will facilitate diversification without compromising the brand and making huge investments.
Franchisees have better chances of obtaining bank financing and having a profitable business when entering a franchise business. Franchises are less risky investments because franchisees need to only replicate a proven business model and also benefit from brand awareness and a built-in customer base.
A franchise business model includes mentorship, training, and ongoing assistance for business partners. Furthermore, a franchise buyer can enter a network of fellow franchisees who can provide advice and support.
Increased brand value
As a franchisor, you will ensure your brand meets the same quality standards in every branch, and that it is easily identifiable and consistent across the different points of sale in the country or state.
Franchises are usually allocated in a strategic position so they won’t compete against each other in the same territory, which allows franchisees to enter a more profitable market.
Disadvantages of franchises
The initial costs of buying a franchise are elevated. Starting from the franchise fee, which costs an average of $35,000. There are also startup costs, which fall between $200,000, and royalty fees, which can typically run as much as 12% of the monthly business revenues. Added to this, both franchisors and franchisees need to consider the costs of a franchise and accountant attorney that will ensure the business is feasible and profitable.
Loss of Control
As a franchisee, you will face plenty of restrictions on how to run the business, and aspects such as the location, hours of operation, signage, or decor. A franchise business usually does not give room for creativity and you cannot make decisions without consulting the franchisor first.
Complexity and regulations
Starting a franchise involves creating a Franchise Disclosure Document, training programs, and operation manuals, and taking care of all the necessary procedures to ensure your business is easily replicable and attractive for investors. A franchise business will be subject to federal franchise law regulations but also needs to comply with the state laws of each of the states it operates in.
Buying a franchise is a complex and lengthy process that involves paying high fees and royalties, setting up the location, taking training, and hiring employees. Added to this, franchisees may face a difficult vetting process. Franchisees need to carefully review the FDD and take measures to ensure they are getting into a profitable deal before making such a huge investment.
Since franchises aim to have a standard business model, they offer a uniform fee structure and the same terms and conditions for all franchisees. It is very difficult for a franchisee to negotiate more favorable terms, so they must typically abide by the stated duties.
Which one is best for your business?
Each business pursues different objectives and is structured in a unique way, for there is not rule of thumb for which strategy should you choose.
Broadly speaking, these are the recommendations on how to opt for a license or a franchise.
You are most likely to be a licensor if:
- Your company is a product-based business
- You are not interested in expanding your whole brand and experience, you are only focused on a specific trademark.
- You want to conduct a simple process to expand your market
- You only have a small amount to invest
- You are not able to create a proven business model and its accessory procedures
You are most likely to be a licensee if:
- Your company is a product-based business
- You want complete freedom to make decisions for your business
- You have enough experience in running a business and are not interested in having assistance
- You are only interested in profiting from a specific trademark
You are most likely to adapt to being a franchisor if:
- Your company is a service-based business
- You have enough capital to make a big investment
- You are willing to create training programs, operating manuals, and all that it takes to ensure your business can be easily followed.
- You understand you will have to comply with strict federal and state regulations
You are most likely to adapt to being a franchisee if:
- You want to have access to a trademark and also the know-how of a company
- You can pay high fees and make a hefty investment
- You are willing to sacrifice the freedom to control your business for stability
- You do not have broad business experience and want to count on the franchisor’s support.
- You are willing to go through a lengthy process to open a franchise
What happens if I pass off a franchise as a license?
You may realize now that licensing is less complex in terms of time, money, and effort than franchising.
However, as mentioned above, if your business is a) Allowing another business or individual to use your trademark b) Receiving a payment in exchange for this right, and c) controlling how this business operates, then your company is legally defined as a franchise.
Even when there is a licensing agreement, another kind of contract, or not even a formal contract involved, as long as your business meets these three elements, it qualifies as a franchise and must abide by the federal Franchise Rule.
According to the law, a franchisor must provide the Franchise Disclosure Document, which summarizes the fees and expenses, the legal relationship between the parties, operating information, and risks of the investment. The franchisee must receive this document 14 days before entering the deal and signing the final franchise agreement. Additionally, you need to comply with the State Franchise Laws.
It is very common for business owners to accidentally create a franchise and continue operating their business normally without following the franchise laws. This omission can result in serious actions, such as fines, lawsuits, and even the shutdown of your business.
See this short video of the consequences of accidentally franchising a business.
Whenever you get involved in a licensing or franchise agreement or any kind of business transaction, always rely on the knowledge of a corporate attorney, who will advise you at every step of the way to ensure you are maximizing your profit while protecting your business.