License or a Franchise Agreement

License or a Franchise Agreement

Do You Have a License or a Franchise Agreement?

California Regulators May Not Agree

Do you have an idea that you want to monetize, but need some help bringing it to market? Do you have an existing business that you want to expand?  You could get financing to open additional locations, grow your sales force, or increase your manufacturing capacity.  However, many business owners do not have the time or risk tolerance to undertake this expansion on their own. In that situation, many businesses look at licensing or franchising to expand.  How are these different and why should you care?

There is a big difference between franchising and licensing, and getting it wrong can mean fines, void contracts, and big headaches.  It is important to create the right relationship by recognizing the limitations of a licensing agreement and avoid the creation of a franchise without the proper planning. 

Licenses

In this context, a license is generally the authority to use someone else’s intellectual property. This is a simple concept, which is a major part of its appeal. Another is that this simplicity generally translates into a less expensive process to get the product quickly to market. However, the owner needs to recognize the limitations of a license, when compared to a franchise.  The difference between a license and a franchise comes down to one word: Control.  With a license, the owner is giving up a much more significant amount of control.

Franchises

Franchise relationships are specific and occur—whether you mean to create them or not—when certain elements are met:

  • The operator obtains the right to engage in a business;
  • The operator’s business is closely tied to the owner’s branding;
  • The operator pays a fee for the right to engage in the business; and
  • The owner provides a marketing plan or system for the business.

Usually, most of these elements are in place whether it is a license or a franchise.  For example, both give a right to engage in the business and there is almost always a fee that changes hands for the right to engage in the business.  The real distinguishing factors are how closely the branding is tied to the business and whether there is a marketing plan or system.

In many situations, an owner wants to make sure that the products or services meet their quality expectations because their brand name is on the product or service.  The owner will put rules and plans in place to make sure that the quality level is met.  When that happens, it is important to recognize that this relationship might be sliding over the line into a franchise.  Asking yourself these questions can help determine whether a franchise relationship is being created:

  • Does the owner set the pricing?
  • Are there prohibitions on the operator offering competitive services?
  • Does the operator have to buy components, ingredients or materials from specific providers?
  • Does the owner have inspection rights to ensure quality?
  • Is there a general marketing plan run by the owner?
  • Does the owner provide training sessions?

Many owners want or need to keep control of their concept, and so they put these plans and restrictions in place.  While this is perfectly acceptable, those owners need to properly create a franchise relationship to avoid the penalties resulting from operating an unregistered franchise. These steps are generally more expensive and time consuming than a license agreement, but that is the tradeoff for maintaining the control inherent in a franchise system.

Conclusion

Although subject to extensive regulation, franchises are perfectly acceptable business arrangements in the right context. However, creating a franchise relationship is not always the intent of the parties involved. Unfortunately for them, California’s regulators care only about whether the transaction meets the elements of a franchise, not about intent. So, before entering into a licensing agreement, be sure that it does not unintentionally create a franchise that will need to be registered. Alternatively, if a franchise is desired, you must properly register and create the franchise relationship.

Contact Mark E. Peterson (mpeterson@diepenbrock.com) or Justin M. Borrowdale (jborrowdale@diepenbrock.com) for assistance in structuring your agreements in the most beneficial way for your situation.