Licensing and Franchising Definition
Both franchises and licenses are business contracts, providing the sharing of specific brand elements in return for a price. A license deal, on the other hand, only applies to registered trademarks. Whereas, a franchising agreement covers a company’s whole brand and operations.
While licenses are more appropriate to product-based enterprises, franchises often work best for service-based ones. Compared to a franchisee, who will have their operations controlled by the franchise owner, a licensee has more autonomy over how they conduct their business (franchisor). But a franchisee will also get a lot of direction and instruction from the franchisor.
While there are some parallels between licensing and franchising, they are two completely different contracts that have very different implications for you and your company. In this comparison of franchising vs. licensing, we’ll discuss the distinctions between the two business models, as well as the benefits and drawbacks of each.
What Is a License?
A license is a permission by a qualified authority allowing a licensee to achieve something that would otherwise be banned, according to the Legal Information Institute. The licensee will have the right to utilize or benefit from a trademark, technology, or other legal rights by entering into a license agreement. For instance, a pharmaceutical business may offer another company the right to use its patented formula for producing that drug.
Contrary to a franchise agreement, the license agreement does not let the licensor exert power over the overall management of the licensee’s firm. Instead, it places restrictions on what the licensee may and cannot do with the licensed asset.
So licensing is a restricted, legal business relationship in which a certain party is given permission to use specific registered trademarks of a company. The licensee and the licensor, who is the owner of the trademarks, are business partners (the one who is granted rights to use them).
The licensee pays the licensor an agreed-upon royalty fee in exchange for the right to use the registered trademarks of another company.
The licensing agreement between Nestle and Starbucks, which they signed in May 2018 and required Nestle to pay $7.15 billion in cash to Starbucks, the licensor, in exchange for the exclusive right to sell Starbucks’ products, is a well-known example (single-serve coffee, teas, bagged beans, etc.).
What Is a Franchise?
Franchise agreements are essentially a way of expanding a business to new markets. By signing this contract, the franchisee is granted the right to run a business and to offer, sell, and distribute goods and services that are connected to or identified by the franchisor’s trademark. The franchisee is also bound to maintain certain standards or characteristics that the franchisor has established.
Franchises are subject to regulation under the FTC’s franchise rule, and state laws must follow it. In accordance with the terms of the franchise agreement, the franchisee must pay the franchisor fees in order to start a franchise, use their brand, and receive business guidance and support. In exchange for a fee, the franchisor lends their brand to the franchisee and offers training and advice.
Compared to licensing, franchising involves a deeper and more intricate business engagement and agreement. A franchisor maintains control over the usage of their brand and the management of any franchise bearing their name. In a franchise partnership, the franchisee and franchisor are highly interdependent.
Examples of Franchising
McDonald’s is among the most well-known franchises. The McDonald’s franchise, which had a modest beginning, currently has more than 36,000 locations worldwide.
Other famous franchise businesses include:
- Burger King.
- Pizza Hut.
- Marriott International.
- Taco Bell.
- Ace Hardware Corporation.
- The UPS Store.
How Franchising and Licensing Differ
You give the franchisor control over your company when you sign a franchise agreement. However, licensing does not exist.
The franchisor can heavily influence the location, standards, and methods of operation of the franchisee’s business. This is so because the franchisee’s enterprise essentially serves as a franchisor’s extension.
But the licensing agreement differs from that. Only restrictions on the use of a certain brand, piece of technology, or formula may be imposed by the licensee. However, it is unable to exercise control over the licensee’s overall operations. For instance, it cannot determine the general policy of the licensee or how its business should be conducted.
In general, there are more criteria to get a legal franchise agreement. Despite the fact that licensing agreements differ from this.
The general contract law is for both of them, but in the United States, for instance, there are particular federal regulations for franchises at the federal level and certain additional requirements at the state level. By looking at the franchise rules, you can learn more about the specifics of franchise contracts in the United States.
Therefore, franchising is controlled by franchising regulations in many countries, while contract law governs licensing. If there are no franchising regulations in place, business law governs.
The license agreement, as previously mentioned, essentially transfers the right to use, produce, and market an idea, design, name, or brand. In contrast, a franchise agreement enables the franchisee to run a company as a standalone branch.
Therefore, in order to carry out a franchise agreement, the franchisor’s continual support is necessary. This is to ensure that its branch is running in accordance with its standards. The licensor’s only commitment during the term of a license agreement is the one-time transfer of assets or rights.
Franchises are more expensive than license agreements. Franchisor must take various types of fees. Franchise fees, royalties, advertising fund and/or brand fund fees, and market launch program expenses are among these charges. But the licensing fees are not the same. So, if you’re a little short on cash, licensing is your best financial alternative.
Check out 4 Key Differences of Franchise and License for elaboration upon advantages and disadvantages of licensing and franchising.
Why Franchising Is Not a Replacement for Licensing?
Despite their similarities, licensing and franchising are not substitutes for one another. It’s critical to comprehend the relationship established by your legal agreements, as well as the rights and obligations imposed on the parties involved, to decide whether your business qualifies as a franchise rather than a license.
According to the Franchise Rule, which is federal law defining and regulating franchises, a franchise must meet the following requirements:
An ongoing business relationship
An oral or written agreement
A trademark’s license (although this is not necessary under certain circumstances)
Control over a licensee’s or franchisee’s operating methods or a duty to support such operating
Verifying a fee to pay
Since points one through three apply to both licensing and franchising agreements, it is usually possible to determine whether a franchise relationship exists based on the fees received at the time of sale and the amount of control a franchisor has over a franchisee’s operations under the terms of an agreement.
If a business’ licensing agreement satisfies the requirements of a franchise, the legal relationship by the agreement is a franchise, not a license, under the federal Franchise Rule.
There is a franchise relationship between the two parties to the agreement, the franchisor will then need to comply with specific legal requirements. These requirements include providing a Franchise Disclosure Document (FDD) to potential franchisees prior to offering or selling a franchise, properly preparing and disclosing the FDD, and, if a franchise operates within the Franchise Registration States, registering and filing additional paperwork in those states.
Entrepreneurs should review their legal agreements to make sure their business interactions are clearly defined and legally compliant due to the potential legal breaches and fines that could arise from failing to meet those commitments.
Which One to Choose?
The answer to this issue depends on your objectives and requirements; if you intend to grow your company OR if you want to emulate the success of another well-known firm, signing a franchise agreement would be the best course of action for you.
However, if you want your company to be fully independent and all you need to increase your profits is a brand or perhaps a formula, you’ll likely need to sign a license agreement.
Additionally, addressing a few questions would be very beneficial in determining which direction to proceed in:
Do you wish to utilize another company’s reputation while maintaining the independence of your own operation?
Are you trying to find a quick and simple solution to boost your company without having to comply with regulations?
Do you have an idol business in mind that you want to implement?
However, establishing a legally binding partnership necessitates a thorough explanation of your situation. Therefore, whenever you want to finalize a license agreement, a franchise agreement, or indeed any contract, never forget to speak with an experienced lawyer in that field.
Once you’ve spent some time figuring out which business model is ideal for you, either franchising or licensing can get your company off to a successful start. Both franchising and brand licensing are areas of competence for Goldstein Legal.
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