Licensing Agreements Defined
Licensing agreements serve as the bedrock for a plethora of key business assets. Most notably, they are agreements whereby the intellectual property owner (the licensor) of a trademarked brand or logo, patented invention, or copyrighted work, grants permission to a licensee to use, produce, and/or resell elements of the licensor’s brand or invention. In return, the licensee typically makes royalty payments to the licensor in order to continue reaping the benefits of the contract. Products such as Coca-Cola® soft drinks and branded toys such as LEGOs® typify such arrangements. These licensing agreements are governed by many of the provisions contained within the Lanham Act, which primarily covers trademark issues.
Licensing agreements provide specific terms for the use of the specific property. For example, the agreement frequently limits the location the licensee can use the property. A manufacturer may wish to sell its Chinese goods in Shanghai, for instance, but only in Shanghai , and not elsewhere.
Licensing agreements are meant to protect both parties in a hypothetical transaction between them. They set up the terms for the proper use of the property, and they also lay out the damages that may come from improper usage. A manufacturer who has licensed its property to a distributor, for instance, may be worried that the distributor will do something illegal or unsavory with the products. If the manufacturer is not careful, the brand may get a negative reputation, even though the manufacturer was not directly involved in any of the wrongdoing. Thus, a license agreement would set out the requirements for how the distributor should deal with its property, and it would provide the manufacturer recourse for due damages if anything goes wrong.
Some licensing agreements grant the trademark owner even more rights to control how a third-party entity uses its properties. For example, Disney® imposes strict requirements on how others use their brand, requiring other businesses to adhere to — at times — very specific rules. The goal, again, is to prevent bad publicity (such as sexism, racism, or violence) from being attached to its brand.
A Franchise Is
Franchising is a business model that gives one party – the franchisee – the right to use a part or all of another party’s – the franchisor’s – business model for a predetermined amount of time. In this model, the franchisee builds and owns the franchise locations, whereas the franchisor provides support to the franchisee to help the franchise locations succeed. For example, the franchisee and the franchisor partner together to create the best way to sell the product and/or service the franchisor is offering.
A successful franchise relationship can be a potentially attractive investment for both parties. In a franchise relationship, the franchisee pays an upfront fee, as well as annual royalties, to obtain the rights to sell the franchisor’s product or service. In return, the franchisor will provide to the franchisee certain supports for how to sell the franchisor’s product or service, such as branding, training, marketing material and restricted territories, among various other things.
The relationship between a franchisor and franchisee is based on a written licensing agreement, which is referred to as a franchise agreement. It is the franchise agreement that sets forth the terms for the rights and obligations of the franchisor and franchisee, including what the franchisee is responsible for. One of the most important responsibilities is complying with the terms of the franchise agreement. If the franchisee breaches (i.e., doesn’t follow) the terms of the franchise agreement, the franchisor has the right to terminate the franchisee’s right to use the franchisor’s business model (effectively shutting down the business).
The franchise model is not industry limited. You can find franchising in almost every industry. However, fast food and retail are two of the most popular industries for franchising.
Licensing and Franchising: The Main Contrasts
In a licensing agreement, the licensor is not concerned with the ultimate appearance of the product. The manufacturer is free to design its own way of producing the product, including choosing the materials and any other features. Once the product is developed, the manufacture will pay the licensor a royalty typically based on the net sales price. The manufacturer may be required to submit samples of products to the licensor for approval, but this is only to ensure that the products bear the proper marks. The licensor typically has no control over the manufacture processes and will have no input on the design of the products.
In a franchise relationship, the franchisor will impose strict requirements on the franchisee, including requirements on where to manufacture, how to produce the products, how to market the products, and how to distribute and sell the products. Strict guidelines are established by the franchisor to ensure that the nature and quality of the products used and sold by the franchisee conforms to the franchise system and does not damage the franchise system. The franchisee is often required to undergo extensive training provided by the franchisor so that the franchisee learns the correct operating procedures. In addition, the franchise will generally include a long list of requirements for the use of trademarks and other branding materials.
Licensing agreements and franchise arrangements are subject to many of the same legal requirements at the federal and state levels. However, there are differences in the registration requirements imposed under federal and state franchise laws.
Licensing Agreements: Pros
Benefits to Licensors
Licensing agreements can be attractive for a number of reasons. For the licensor, these arrangements provide an opportunity for revenue generation and a strategy for market expansion through broad distribution without the cost and liability of owning the mark.
It can also benefit the licensee, who may gain a competitive advantage by acquiring the additional distribution network and advertising power. While franchising offers many advantages as a traditional business development strategy in certain industries, licensing can provide greater flexibility as a form of brand extension for nontraditional model franchises.
Franchising: Pros
For franchisors, the most obvious benefits are access to quick capital for expansion and the ability to open new locations with less debt. Franchising also results in less scrutiny by lenders and permits the franchisor to retain more control over franchisees than a licensing agreement would, given the specific nature of many franchising agreements. Already existing operational structures, staff and personnel can help with training and guidance for newer franchises, and proven business practices and support systems are easily adaptable to local or regional markets .
Franchisees benefit from a well-established, market-tested business model that grants them a competitive advantage. By entering into a contract under a trusted and ubiquitous brand name, franchisees enjoy reduced risk factors that make the operation far more likely to succeed than most other small businesses. Franchisees also benefit from the large pool of people whom they can approach for financing and advice, as both franchisees and franchisors have a strong incentive to work together in order to grow the brand-name business and increase individual profits.
Lawful Licenses and Franchises
When entering into licensing or franchising arrangements under state law and/or federal law, it is important to consider how the law will interpret these arrangements. The contractual obligations between the parties will set the parameters of the contractual relationship between a licensor/franchisor and licensee/franchisee. After determining whether the licensing or franchising arrangement constitutes a licensing or a franchising arrangement, legal counsel is often helpful in advising the licensor/franchisor on complying with applicable intellectual property laws, such as federal copyright and trademark laws and regulations, and state consumer protection and franchise laws.
The following sections provide an overview of the key legal considerations one should keep in mind when exploring licensing and franchising relationships from the perspectives of licensor/companies that own the intellectual property and franchisors.
Franchising or Licensing
The decision between entering into a licensing agreement or offering a franchise often reflects a range of business goals and considerations. In some cases, licensing agreements offer greater flexibility and autonomy, while franchising provides a structured business model and extensive support to those who have the internal resources to implement such a system. In general , the key factors for businesses to consider when choosing between a licensing agreement and a franchise include:
- Business Goals: What do you want to achieve from the licensing agreement/franchise? Do you see licensing as the best option for the future of your company?
- Resources: Do you have the resources on both financial and human capital levels to build a franchise model?
- Risk Tolerance: Are you willing to assume the risk associated with a franchise agreement?
Funding is an important element in deciding between licensing and franchising, and developing a realistic budget for operations is essential either way.