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Every franchise is a license, but not every license is a franchise."
Sounds confusing, right?
People often get franchising and licensing mixed up, thinking they're similar business agreements, but they're not.
We'll break down the difference between licensing and franchising after defining them to show their similarities. And ultimately, explain why you should care.
Because if you're investing in a business opportunity but don't know which route to take, hopefully, you'll get a better idea of what these two business models entail to make an informed decision.
And if your company is looking to expand, you'll have a clearer picture of what scaling it would be like when you decide to franchise or license it.
You'll soon realize why some entrepreneurs and businesses have their reasons for preferring one business model over the other.
Franchising and Licensing Look Virtually Similar
Let's define franchising and licensing for a side-by-side look.
- Franchising: It's a business model where the founding company (the franchisor) decides to "license" or grant you the rights to own and operate a copy of their business as a franchisee with everything needed to run that franchise.
You both sign a legal contract (franchise agreement), which authorizes you to use the franchisor's branding, intellectual property, training manuals, business systems, products or services, etc.
You pay the franchise's start-up costs and recurring royalty fees. In franchising, you follow the franchisor's direction and control in how they want you to operate their business.
Basically, franchisors run a tight ship.
- Licensing: This model involves a two-party legally-binding contract (licensing agreement) between you and the licensor.
They're authorizing you, the licensee, to use the licensor's trademark, trade name, intellectual property, patents, design assets, logos, products, etc.
You still have to pay upfront costs and royalties as well as abide by the licensor's guidelines in properly using their intellectual property.
Starting to notice some similarities? You can see why it's a little confusing.
Licensing and franchising both involve the authorized use of trademarks and proprietary assets to run the business, signed legal contracts, start-up costs with recurring fees, etc.
But the major similarities stop there. Here are the subtle differences between franchising and licensing explained below.
What Are the Differences Between Franchising and Licensing?
With franchising, you get to run the whole business, use their branding, hire employees, receive training and operational support from the franchisor, etc.
You call the shots throughout the daily operations as a franchise owner to a certain degree under the franchisor's control.
That's not the case if you're a licensee; there's little to no oversight by the licensor, extensive training, or support from them.
Licensing gives you the right to specifically use their trademarks, technology, logo, be able to sell white-labeled products, etc. Essentially you're granted permission to use a piece of the licensor's intellectual property and copyrighted material.
Licensors don't fully control their licensees as much as a franchisor would manage its franchisees. Franchisors supervise franchisees to see if they're running their franchises accordingly to ensure customer experiences across locations are consistent, for example.
Here's another thing about territories and who can operate where.
Some franchisors have set territories for their franchisees, so only one of them can serve in that specific area. Although, that's not always the case, unfortunately (e.g., Subway). Still, it's possible to have your franchises in one city without new franchisees competing with you in your designated territory.
On the flip side, licensors could have multiple licensees selling products or services in the same area.
So far, you've seen how franchising and licensing look similar, and now you've learned some of the differences.
But our federal laws dictate those differences even further. You'll learn about this in the next section to get an idea of what kind of business agreement you're getting into.
Franchising vs Licensing: How To Tell the Difference Legally
So what makes a franchise…
a franchise?
For one, as stated by the
Internicola Law Firm, franchising and licensing differ in how they are controlled at the state and federal levels.
Franchises are governed and regulated by the Federal Trade Commission (FTC).
There are strict federal laws in place (and 19 state laws) that define the franchisor and franchisee relationship under the
FTC's Federal Franchise Rule.
Licenses are not governed by specific federal or state laws,
except contractual laws that protect the misuse of licensed marks or intellectual property. Hence why licensing has a less restricted business relationship in how licensors control licensees.
But why is this important, and why should you care?
It's important to recognize what kind of business relationship you're getting into: Is it a franchise or license agreement?
With licensing, it's treated just like any other legally-binding commercial contract you would sign.
In franchising, the Federal Franchise Rule requires franchisors to provide legal documents detailing their business opportunity to you beforehand. One of those documents is the
franchise disclosure document (FDD).
What's detailed in there varies per franchise opportunity. And it gives you a chance to see what the potential partnership would look like under the direction of the franchisor.
The FDD has 23 sections describing all the information you should know about, such as the franchise business and its model, what the franchisor's/franchisee's obligations are, how long the two-party relationship will last, and so much more.
The FDD must be reviewed by you and signed within 14 days, along with a signed franchise agreement to start the relationship. Once signed, you as a franchisee have to abide by that contract to the T.
Our next section explains why you should absolutely have a franchise lawyer review the FDD and franchise agreement with you before signing. The same advice of having a lawyer applies to licensing too.
Legal Pros Should Review Contracts With You
Even if the document's title says it's a license or a franchise, that may be misleading. You'd be surprised how many
"licenses" are really franchises, violating franchise laws because someone decided to take an illegal shortcut.
An experienced attorney can review the document detailing the business opportunity and tell you whether it's a license or a franchise.
Here's one way a lawyer could tell you it's a license in the contract.
The trademark owner explicitly states that they have the right to oversee your use of their property if it's misused. They will also point out that a licensor has the right to make changes to their trademarked material.
To know if it's a franchise, a lawyer will explain to you how the trademark owner has these legal rights we just mentioned but also has the right to dictate how you run your business, how it looks, what you sell, hours of operation, etc.
And if they provide you training and support plus marketing, then it's most likely a franchise.
Franchise lawyers can tell the difference between licensing and franchising based on the structure of the fees too.
Licensing has an initial fee and ongoing royalty fees (sometimes monthly/yearly) to use their property, but franchising has other costs beyond those two kinds of fees.
Most franchisors charge you a percentage/flat rate to help pay for marketing, further development of goods and services, and whatever is needed to support the franchise system as a whole.
With licensing, you're on your own with how you market the licensed material and how you support business developments to drive growth.
So always do your due diligence when researching opportunities. Survey existing franchisees or licensees to see if the business is right for you. Have a lawyer explain legal documents in plain English to know what you're getting into.
Now, if you're a company founder and wish to expand, should you franchise or license your business?
Let's look at some real-life examples to see what each route looks like. And these examples could help you choose the business model you're most comfortable with if you're looking for an opportunity to venture in.
Licensing and Franchising Examples and Things To Consider
Here are a few
brands that engage in licensing:
- Walt Disney: Disney makes billions selling merchandise globally by granting licenses to companies to create all kinds of products for them featuring Mickey Mouse or other Disney-owned characters. In return, these companies earn revenue by selling products featuring licensed Disney material.
- Netflix: Not everything on Netflix is original content. In fact, people have sold their content to them, and the majority of shows and movies are licensed to Netflix for a limited or indefinite period of time.
- Calvin Klein: Only a small percentage of Calvin Klein's clothing is made by them. Fashion and beauty companies frequently purchase licenses to sell products with their branding, but other manufacturers make the physical product.
- Starbucks: Believe it or not, Starbucks doesn't franchise their business. They grant licenses to people who've applied to sell their products, but they don't own the store—Starbucks does.
Examples of franchise businesses are everywhere:
McDonald's, The UPS Store, Planet Fitness, Holiday Inn, 7-11, etc. The real question here is which business model may be ideal for you to invest in or expand with?
Franchising vs Licensing: Advantages and Disadvantages
Franchising and licensing have their pros and cons as well as tradeoffs.
Here are some advantages and disadvantages if you're a business founder:
- Advantages: Licensing might appeal to some business owners because the barrier to entry is easier, cheaper, and has way fewer laws and regulations than franchising. You have the potential to earn income off licensees using your trademarks, and it serves as an extension of your brand.
Franchising could allow you to scale your business inexpensively by shifting the cost of new locations and the work involved to manage them to franchisees.
- Disadvantages: Besides being limited in what you can offer to licensees, a possible disadvantage of licensing is that your brand has to be recognized by many (see our examples above) for it to be worth starting.
There's a chance you won't receive much from royalties if your product and brand are starting to take off. Another downside is not being in full control of how licensees market, promote, or handle their business with your licensed marks.
Franchising could be disadvantageous for similar reasons of not having a big enough brand to support expanding it, but it's the arduous process of registering your business with the FTC and complying with their laws that may be off-putting to some. That's why some franchisors illegally license their business to avoid franchise laws.
- Tradeoffs: Both business models could allow you to reach a wider pool of new and existing customers and may boost brand awareness and authenticity.
What are the pros and cons if you're looking for a licensing or franchising business opportunity?
- Pros and Cons for Licensees: The pros of being a licensee are having more control over your business and the ability to sell someone else's intellectual property on consumer products or clothing, for example.
As a licensee, cons could include lacking the licensor's support and relying on yourself to be successful. There's the possibility of competing with others in the same area or selling products in a saturated market is another downside of licensing.
- Pros and Cons for Franchisees: Franchisees could enjoy the benefit of buying a turnkey business where everything is figured out by the franchisor. A possible con of being a franchisee is the lack of control you have over the franchisor's business, and the overall costs of franchising may not be cheap versus signing into a licensing agreement.
That's why some people (not all) prefer licensing since it could be an affordable avenue to get into business. But those who are in it for the long haul and don't mind being managed to a certain degree to own a potentially successful business may prefer franchising instead.
Choose What Makes Sense for You
If you're looking for a business opportunity or expanding your business, the choice depends on your goals.
If you want to franchise or license your business, consider your business's viability and what you offer.
Licensing your business could be the best route for you if your company sells products. If the brand is strong, gaining recognition, and doing well financially to support the expansion of multiple locations, then franchising may be the proper avenue.
As a potential licensee or franchisee, choosing your business venture depends on what you want out of the business agreement.
If you're a seasoned entrepreneur and prefer to control what you sell and how you do business, then licensing may be best for you.
Suppose you prefer owning a business with an established brand and customer base, tested products and/or services, and fully fleshed out operating procedures with training/support. In that case, you might enjoy the franchise route, so try to find the perfect opportunity right here on All USA Franchises.
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