Licensing is a legal relationship where a party is granted a limited right to use a particular trademark or technology in exchange for a royalty fee. The relationship between licensor and licensee is limited to the licensed trademark or technology. Franchising is a more advanced form of licensing and involves more control and interdependence between franchisor and franchisee. Licensing is not an alternative to franchising.
If you are interested in licensing vs. franchising then it is probably because you are evaluating whether or not you should franchise your business and whether or not licensing is an alternative. Unfortunately, except in extremely limited situations, i.e., like if you’re The Hershey Company and you are licensing the Hershey name for someone to put on t-shirts, licensing is not an alternative for franchising and is not the way to legally grow your business. I say legally, because many who use licensing as an alternative to franchising, unknowingly violate the federal and state franchise laws and create legal issues for themselves.
To provide more detail as to why licensing is not an alternative to franchising, below we discuss why and what a fight between licensing and franchising looks like and how licensing loses the fight. Also, in our franchising vs. licensing guide we explain why and how “…licensing may be a trap that damages your business”. I definitely recommend that you read the guide. Now to the fight! expansion and growth of your business.
So, how do you expand your business and what are your options. Well first and foremost is the tried and true “organic expansion” where you open up more locations. But for many franchising represents the vehicle of choice of multi-unit expansion. So where does “licensing” fit in and in the business expansion battle of “licensing versus franchising”, is organic expansion a contender and what expansion model comes out on top when it comes to what is right for your business.
At the most basic level “Organic Expansion” is the starting point for everything. That is, you establish a business, you learn from many mistakes, adapt, work hard and create success. You build a business with a brand, customers and systems from marketing and delivering value to your clients. So, the issues of expansion arises and more often than not it comes about organically…you open a second location, duplicate your business model and operate two locations. So, in our imaginary battle in Round 1 – organic expansion is the winner. Mostly because Franchising and Licensing have not entered the ring. So round 1 goes to organic expansion by default.
Winner Round 1: Organic Expansion by Default
So organic expansion works and can work well beyond one, two and many other locations (think Starbucks) but for the purposes of demonstrating the differences between all these business models and facing what many other entrepreneurs have learned, organic expansion does present some challenges, i.e., a drain on capital where you run out of money to open a third or fourth location and you need managerial help because you can’t be everywhere) So, franchising and licensing enter the arena.
Lets learn more about these contenders:
Licensing – Licensing is a strong up-start competitor, it is strong and fast and seems like it has everything (light and fast without some of the extra weight that franchising carries around. However licensing has a weakness and if exposed is fatal. See below. Licensing is definitely a useful form of expansion but one that requires caution. In terms of “licensing,” as a Licensor, you will be granting a third party (known as the licensee) the right to utilize your trademarks and, possibly, your business systems and intellectual property. The benefits are that you will generate additional revenue in the form of a “license fee” and licensing may serve to expand consumer recognition of your brand. The detriment is that you will have to carefully structure your license agreement to ensure that it does not qualify as a franchise. From a legal standpoint, license agreements are extremely limited. That is, other than granting a “license” to use certain trademarks and intellectual property, you will not be permitted to exert control over your “licensee.” Moreover, license agreements in many instances cross the “legal line” and fall within the definition of a franchise. So, a license agreement, if not properly drafted and restricted, may subject you to franchise liability.
Franchising – Franchising is strong, weighs more than Licensing and slightly slower. Franchising starts slower than licensing but once franchising gets going it is quite strong. Franchising still has weaknesses but they are not fatal. See below.
Franchising is certainly a proven business and legal model for multi-unit expansion. This cannot be denied. Unlike licensing, franchising does present some regulatory hurdles, i.e., the need to prepare a franchise disclosure document (“FDD”), FDD registration and certain state specific franchise relationship laws. But when done correctly, franchise regulation can benefit the franchisor and franchising offers the successful business owner a solution to their expansion dilemma: franchised expansion occurs with the assistance of the capital and managerial efforts of what we would hope are qualified franchisees.
Winner Round 2: Draw. During this early stage (i.e., 6 months to 18 months in the expansion process) Licensing looks strong and but franchising holds its own and in a controversial scoring the round is a draw.
Although licensing remained dominant its weaknesses were exposed. Along the way it turns out that made up labels don’t matter (i.e., just because you call something a “license” doesn’t mean that it is not a “franchise”), but the nature of the relationship does matter (i.e., is there a trademark license, do you have control and are fees going to be paid to you) just calling your business a “license” doesn’t make it so.
That is, franchise regulation may still apply (in my experience much more likely than not) and when you consider that your goal was to expand and duplicate your business model all of a sudden you see the need and requirement to control how your claimed licensees operate and with that control (coupled with a trademark license and fee) it turns out you are really a franchise.
Worse, you violated the franchise laws and left yourself exposed to a haymaker. One of your licensee’s complains and now you start asking: “How do I convert my license to a franchise?”, “How do I avoid excessive fines?” and “How do I avoid rescinding my existing license agreements”.
Licensing has a role but it should never be to serve as a substitute to franchising or as some smart idea of getting the benefits of franchising without the effort. To learn more about licensing vs. franchising get the guide. To learn more about converting your license system to a franchise, click here. To learn more about franchising your business, click here.
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