A Guide to Franchises
A franchise is an agreement where a prospective franchisee is granted the rights to open a business under an established brand name. Franchises usually require payment of an upfront fee, recurring royalty payments and introduce a new business owner to an established supply chain, business model and customer base. In this agreement, the existing business is the franchisor and the prospective business owner is the franchisee. To protect the integrity of the brand, the franchisor usually imposes a first right-of-refusal obligation on the franchisee, and in some instances, individuals even must buy existing rights out of a geographical location before they are allotted their own franchise agreement .
Franchises are popular for consumers because they are domestically well-known and widely-used brands. They are also easy to start because a franchise has its own successful model that the franchisee is able to mirror in their own establishment. In the past, franchise agreements have been advertised using phrases like "be your own boss" or "be your own manager, while we take care of advertising." Franchise relationships are governed by the Federal Trade Commission (FTC) and state law, which requires substantial disclosures from the franchisor to the franchisee, and gives franchisees some authority to apportion their risk. However, if a franchising entity pulls out its financial teeth, then a franchisee does not stand to gain substantially from this franchise relationship.
What Are Licensing Agreements?
Licensing agreements are common in terms of intellectual property law. Licensing agreements generally deal with the ownership of copyrights, patents, trademarks, and even trade secrets. Broadly speaking, a licensing agreement is a contract that gives another entity permission to produce, sell, or use a good or service.
There are many parties involved in licensing agreements. For example, take shoe designs. If a company wants to use a shoe design with a new product, it usually needs a licensing agreement from the designer. This agreement would typically grant them the right to manufacture, sell, and use the shoe designs in question.
The rights that licensing agreements transfer vary depending on the business and its needs. Some licensing agreements may just cover one or two uses of a product, and only for certain times. These agreements typically have an end date. Others are much longer lasting.
Licensing agreements are primarily between the party who has created or invented something (the inventor) and the party interested in using it (the licensee). As with franchise agreements, there may be a third party in a licensing agreement. A one-contract system, where a company pays the licensee and receives all the benefits of licensing, is a common example of this.
The licensor is the entity that owns or created the product in question. The licensee is the person or business that wants to use the rights of the product. The purpose of licensing agreements is giving the licensee access to the product without relinquishing ownership of the product itself.
Degrees of Control and Autonomy
The level of control a parent company exerts over business operations can vary significantly between franchising and licensing. Franchising encompasses a broad spectrum of brand requirements, such as overseeing service quality, terms and length of employment, and general operational protocols. The franchise model permits retailers to conduct business in a way that a parent company finds acceptable, including its set of regulations. In this situation, a franchisor holds ultimate responsibility and control for day-to-day operations; it also receives a percentage of profits.
In a licensing agreement, a company, like a movie studio or a top clothing manufacturer, provides the means for other entrepreneurs to run their businesses under its name. While the parent company may set brand guidelines and quality standards for the products sold within its name, it does not dictate the standards for daily operations. Many independent businesses are able to operate under one cohesive umbrella of a single name. Although licensing structures do not place limitations on a licensee, the licensor does retain some say in how a business is run. It can terminate a licensing agreement for repeated infractions or if a licensee fails to uphold requirements.
Fees and Financial Obligations
Under a franchise agreement, a royalty payment (usually a percentage of gross sales) may be owned to the franchisor. A franchisee is also expected to make an initial franchising fee payment and possibly pay for other items, including supplies that carry the franchisor’s name or logo. The details in regard to the above items are found in the franchise agreement executed between the parties.
A licensing agreement may or may not require an initial fee and the licensee may or may not owe the licensor a percentage of its sales. It is important to understand that the exact terms of the obligations between the parties in regard to initial and ongoing payments is not fixed by law. Parties who enter into a licensing agreement or a franchise agreement are free to determine the terms that will govern their agreement.
Obligations of a Licensor and Licenses
While licensing agreements are not subject to the same levels of regulations as franchise agreements, none the less, this does not mean that licensing agreements are free for all. It must be kept in mind that licensing deals are subject to the laws of general contracts and any infringements upon them may have serious legal implications. A licensee may not charge fees that exceed the mutual agreement between the parties, unless a separate written stipulated provision permits it. Furthermore, any trade secrets or registered trademark issues must also be kept in mind.
Licensing, unlike franchising, is also not registered with any regulatory body. However, it should be mentioned that if the trade name or logo used by the licensor is a registered trademark, the licensee must ensure proper use of that mark as per the stipulations of the contract. This is because only the application of a trademark does not make it a registered one. Once the licensor gives permission to the licensee to use their mark on their products, they have legally permitted them to do so. In this case, any non-compliance by the licensee would amount to infringement. The licensor, under such circumstances , would have to file an infringement complaint with the relevant court to stop the use of the legal mark.
In the US, the federal agency that supervises franchising is the Federal Trade Commission (FTC). It mandates that franchisees should be provided with a Franchise Disclosure Document which must contain details of the franchisor and franchisee relationship. The laws governing franchising can also vary from state to state. For instance, certain states may prohibit the sale of franchises in their states unless the franchisor is suitably registered, permits have been taken and appropriate fees are paid.
Various issues and problems can creep up in established franchises, as well. In the event that a ranked franchise fails to continually meet the Air Clearance budget standards, a board review would determine whether the franchisee ought to be financially penalized with lower Air Clearance payments or face termination. Similarly, after the end of 10 years, the franchisor has the primary right to renew a franchise agreement. However, if a franchisor fails to maintain the quality of its products, services or general reputation, it could be possible that their franchise is terminated if it is in the interest of the financial health and brand image of the franchisor.
Pros and Cons to Business Owners
Franchising comes with powerful advantages. Buying into a franchise gives you access to a well-established brand and marketing, a proven system of operations, and more. That said, franchising also involves ongoing royalty expenses. Joining a franchise requires an initial investment up front, and a franchisee must continue paying a monthly royalty that can be as high as 10% of sales.
Licensing does not require any type of royalty payment, and there are no franchise fees. However, a licensing agreement is a much more hands-off partnership, and business owners growing through licensing do not often get to control their brand image once they hand over the intellectual property contract. As the franchise model is a higher-investment option, it does ultimately make more sense for mid-level to large businesses looking to expand than start-ups. Licensing, however, is often a better fit for smaller entrepreneurs, including places like food trucks, where growth needs are less intense.
On the surface, the differences between franchising and licensing seem straightforward. However, there are many more intricacies involved in either type of relationship. These small distinctions are critically important for any business owner who is considering an expansion. Talk things through with an attorney who has franchising or licensing experience.
Examples and Case Studies
To better illustrate the differences between franchise and licensing agreements, it can be helpful to look at some real-world examples.
Franchising
McDonald’s is a multiple franchise system in which a franchisee pays a fee for the right to operate a store in exchange for access to McDonald’s branding and potentially supply access to a supply chain. The franchise agreement will also generally obligate the franchisee to follow rules and procedures that are expected for all franchisees regardless of geography. In particular, if a new McDonald’s menu item is introduced, the franchisee may be required to offer the new item to customers, even if McDonald’s is unsure as to whether customers will respond favorably to the new item.
Licensing
Harvard University is a well-known example of a multiple licensing system. The university grants licenses to third-party producers for various restaurants and products. Although there is extensive oversight by the university over the quality of the use of its branding, the university has little control over how each restaurant is run or the product sales process. A Harvard-branded restaurant licensee is expected not simply to replicate Harvard’s business model, but to create and implement its own business plan within a set of established guidelines. In contrast to the McDonald’s franchisees, the Harvard licensees are free to create their own product mixes and hiring and training practices, so long as the product maintains an acceptable level of quality (which is determined at Harvard’s discretion).
Which Is Right for You
Before you embark on the decision of whether to opt for a franchise or a licensing agreement, it is crucial to examine the goals of your business and the areas in which you aim to grow. Understanding your business needs is the center-point of being able to select the right option.
In order to assist in making a wise decision, consider the nine points below:
- What is more important?
- Are you seeking the instant recognizability or have the reputation security of a franchise or would you prefer a more flexible and entrepreneurial system from a licensing agreement?
- What are the regulatory requirements?
- You will need to obtain the necessary licenses and permits for either option.
- What are the brand standards?
- A franchising agreement usually demands strict quality control guidelines and standards, whereas a licensing agreement is less stringent.
- What is the likely length of agreement?
- A franchise agreement is typically longer than a licensing one (e.g. 5 to 10 years as opposed to 1 to 3).
- How often should payments be made?
- Does your business model allow for Trademark Licensor Royalties? Your payment schedule will depend on this, as franchising agreements ordinarily require the payment of royalties to the franchisor .
- Is your business concerned about territory infringement rights?
- For a franchise agreement, you are unlikely to have rights to territory protection, whereas a licensing agreement has the option of strict regional protection.
- What is the purpose of the contract?
- The success of a licensing agreement rests on the marketability, strength and recognizability of the brand you choose to license, not how the product is created or sold. On the other hand, a franchise agreement is concerned with the product or service itself, not its brand or trademark.
- How much do you know/need mentoring?
- It’s important to realize that there is no fast track or set timeframe of how long you and your team need to be trained for either agreement. However, franchising is more likely to involve mentoring than a licensing agreement.
- What are your channels of distribution?
- Will your product require a different channel of distribution than that which is used by the original company that provides its core service? If so, franchising may be a better option as licensing primarily uses the same channels of distribution.