Differences Between Licensing and Franchising
Licensing and franchising are two forms of business agreements that typically involve the license of a trademark and the shared use of brand elements, technologies or systems in the operation of a business. License agreements are more limited than franchise agreements and involve the shared - licensed - use of a trademark, technology, or business system between businesses that operate independent of one another and use their own individual and distinct brands. Franchise agreements are broader than license agreements and, in addition to licensing the use of a trademark, regulate and control the entire branding and operations of franchised businesses that operate under a singular brand and using the same systems, supply chain, and operating procedures.
Summary of the differences between licensing and franchising:
- Different Levels of Control - License agreements are limited to granting another business the right to use a trademark or technology but does not include control over how the business operates. Franchise agreements are broader and control how a business operates.
- Different Legal Regulations - License agreements are governed by general contract law. Franchise agreements are regulated by federal and state franchise laws.
- Different Business Goals - License agreements are used to monetize trademarks and technology through independently operated businesses. Franchise agreements are used to grow a brand through outlets that operate under uniform systems controlled by the franchisor.
What is Licensing?
Licensing is a business agreement that involves the shared use of a trademark, technology or other intellectual property asset. The agreement that creates a license relationship is a license agreement and the parties to a license agreement are the licensor and licensee. The licensor is the owner of the trademark or technology and, based on the terms of the license agreement, including the payment of a license fee, the licensee is granted a legal right to use the licensor's trademark or technology. License agreements can be exclusive or non-exclusive and can relate to a wide range of intellectual property assets that include trademarks, copyrights, patents, and music. License fees can be structured as a one-time fixed fee or on-going fees based on usage, sales, and other performance criteria.
License agreements are similar to franchise agreements in that they both relate to the shared use of business assets and intellectual property rights. License agreements are different from franchise agreements in that license agreements are more limited than franchise agreements and do not provide the licensor with control over how the licensee operates the underlying business. If a license agreement is prepared improperly and includes too much control over the underlying business, the license agreement may give rise to an illegal franchise relationship.
Examples of license agreements, include:
- The license of a trademark where the licensee is granted the right to use a trademark for a limited and specified purpose. Example: Walt Disney granting McDonalds a license for McDonalds to co-brand McDonalds Happy Meals with a Disney trademarked character.
- The license of a technology where the licensee is granted the right to use the licensor's software, or other intellectual property asset. Examples: Apple granting individual computer users a license allowing them to use the Mac operating system and, Spotify granting subscribers a license to listen to music on the Spotify network.
- The license of a patent where the licensee is granted the right to use a patented process or technology. Example: A patent owner granting a drug manufacturer a license to use the patented formula in manufacturing and selling a prescription drug.
In each licensing example, the underlying business operations of the licensor and licensee are distinct from one another and, unlike franchising, the degree of control that the licensor possesses over the licensee is limited to the underlying trademark or technology that is the subject of the license. Using the McDonalds and Disney Happy Meals example, although Disney will have say and control over how McDonalds uses Disney's trademarks on McDonalds Happy Meals, Disney does not have control over McDonald's overall business operations.
What is Franchising?
Franchising is a business agreement that includes the license of a trademark, the payment of a fee, and control over how the underlying franchised business is operated. The agreement that creates a franchise relationship is the franchise agreement and the parties to a franchise agreement are the franchisor and the franchisee. The franchisor is the company that owns the trademarks and has created the systems and procedures for developing and operating a franchised business. Under the terms of a franchise agreement, the franchisor grants to the franchisee the legal right and obligation to develop and operate a new franchised business location. The franchisee is required to pay to the franchisor an upfront fee known as an initial franchise fee and on-going fees known as royalties. Unlike a license agreement, franchise agreements are intended to duplicate a brand, its business model, and its on-going operations. Franchise agreements require uniformity and within a franchise agreement, unlike a license agreement, the franchisor is granted extensive control over how the underlying business is operated.
Examples of franchises include restaurants like McDonalds, retailers like GNC, healthcare providers like American Family Care, service providers like RE/MAX, and many other businesses and industries. To learn more about franchising read our Ultimate Guide to Franchising Your Business.
Why Licensing is Not an Alternative to Franchising?
Although licensing and franchising are very similar, licensing is not an alternative to franchising and there are important differences.
License agreements are limited in scope to a business relationship between two businesses that share a common brand element or technology but, overall, operate independent of one another and without control over how the other operates and conducts its own business. Any control involved in a license relationship is limited to the use of the shared brand element or technology and represents only a small portion of the overall business operations. On the other hand, franchise agreements are much broader and, in addition to a businesses shared use of a brand, technology, and systems, regulates and controls the entire branding and operations of the underlying business.
Every franchise agreement includes a license but not every license agreement creates a franchise. What qualifies as a franchise is determined by the Federal Franchise Rule issued by the Federal Trade Commission. Under the Federal Franchise Rule, a franchise is created by any written or oral agreement that:
- Creates a continuing commercial relationship;
- Grants a trademark license (although this is not required under certain circumstances);
- Controls how a business is operated; and
- Requires the payment of a fee.
Because points one through three are common to both licensing and franchising agreements, establishing whether a franchise relationship exists typically relies on the fees received at the time of sale and the level of control an agreement grants to a franchisor over the operations of a franchisee.
Under the federal Franchise Rule, if a business’ licensing agreement meets the criteria of a franchise, the legal relationship established by the agreement would be interpreted as a franchise – not a license.
If a franchise relationship is found to exist between the two parties in the agreement, the franchisor is then obligated to meet certain requirements under federal law. These requirements include issuing an FDD to prospective franchisees prior to offering or selling a franchise, properly preparing and disclosing the FDD and, in cases where a franchise operates within the Franchise Registration States, registering and filing additional paperwork in those states.
Because of the potential legal violations and penalties that could result from failing to meet those obligations, entrepreneurs should assess their legal agreements to ensure their business relationships are properly defined and legally compliant.
Advantages and Disadvantages of Licensing and Franchising
The advantage that licensing has over franchising is that license agreements are basic legal agreements that, typically, are not regulated and are less expensive to create. Franchise agreements are regulated by federal and state franchise laws, require FDD disclosure, registration within franchise registration states and, compared to license agreements, involve more legal steps and legal expense. The disadvantage of licensing is that license agreements are extremely limited in what they can regulate and control and, license agreements cannot be used to achieve the multi-unit expansion of a trademarked brand with uniform systems and quality control standards.
When it comes to the future of your business, “dressing up” a franchise as a licensing system can carry serious risks. In addition to legal costs and future negative FDD disclosures, violating franchise laws – even accidentally – can result in government actions, fines, civil lawsuits, rescissions and more.
The difference between licensing and franchising is extremely narrow and is determined by the degree of control created by the underlying agreement. Franchising is used to achieve the multi-unit expansion of a brand through franchised locations that maintain and operate under uniform systems and standards. Licensing is used to monetize trademarks and other intellectual property assets by allowing licensees to use the licensed assets within independently operated businesses. Licensing is not an alternative to franchising and if a license agreement includes the license of a trademark and control over the underlying business operations, it may qualify as a franchise agreement.