Franchising versus Licensing: A Comparison of Obligations and Features
By Lori Karpman
Lori Karpman is one of Canada’s leading experts on franchising and multi-unit business development models as well as a sought after coach and speaker.
Lori Karpman can be contacted at lori@lorikarpman.com or at 514-481-2722. Click here for more information on Lori Karpman & Company.
Franchising and licensing are two forms of business development models where a party, either a franchisor or a licensor, grants to a third party the rights to use its intellectual property within a specified territory for a defined, in accordance with the brand’s rules and regulations. In both cases an Initial Fee is paid and they are usually in the same price range. The typical franchise term is 5 to 20 years, versus a license term which is much shorter at 2-3 years for the initial term. From this point on the models are actually strikingly different, polar in some ways. The level of control over daily operations and the requirement of a (bricks and mortar) “location” are the two main differences that sets these models apart. The levels of responsibility of the parties to each other are drastically different. In licensing the level is reduced, whereas in franchising, because of the necessity of consistency amongst all locations, it is higher.
A Franchise Agreement is a thick document with Schedules and Annexes and over 100 pages. A Licensing Agreement could be 20 pages with a Price Chart attached. I do know from experience that licensing can be very complicated however, there is no legislation holding it back so an agreement is generally negotiated and closed much quicker than a franchise sale. The requirement of having to provide a Disclosure Document is considered very onerous and makes many franchisors uncomfortable. Licensing has no similar disclosure regulation. A Licensing Agreement will cover issues that a franchise agreement would not such as, Performance Criteria, Placing Orders, Shipping Costs and the like. Additionally, a license agreement is given with a “Style Guide”, which is a manual with all the forms of the logo digitally and in print, and the instructions on how the logo is to be used in their advertising materials. All marketing materials must be approved before they can be used, just as in franchising. A franchise agreement comes with an “Operations and Training Manual, and an Employee Manual”. These are separate 100+ page manuals that set out every single step to be taken in a day in the life of franchisee. Everything is provided by a franchisor to the franchisee, all the tools they need to be successful. The franchisee’s only obligation is to use the tools. I always wonder how operators complain that business is down when they are not following the system they bought (?). People forget that they bought a franchise because it was a system, yet they fail to follow it and wonder why their business has dropped (???) I always tell my client that the day they stop following the system is the day they start losing money.
The number one factor that judges look for to determine the business model is control; who had control over the day to day business of the franchisee/licensee, as the case may be. A franchisor has 100% control over the operations of the franchisee including the selection of the location, the daily procedures, employee policies (especially uniforms) and procedures, operating hours, advertising and marketing, new product development, training etc. The mutual rights and obligations are set forth in a Franchise Agreement that with all the attachments is often close to 100 pages. In licensing however, the sections cover with issues such as ordering, payment, delivery and performance. It’s much more practical, but most importantly but the licensor does not get control over any business policies, working conditions or decisions of the licensee. The only thing a licensor has control over is the use of its intellectual property, and how the products are merchandised in retailer’s stores. In certain cases it is very clear, such as any business requiring a physical location with signage, that would have to be a franchise.
On the financial side, both models require an initial payment and they are often comparable to cost. Licenses don’t sell for less as they can easily generate far more than a franchise. During the term of the agreement, a franchisor will receive ongoing payments of royalties and ad fees whereas a licensor will reap his profits from the sale of products to the licensee.
Last but surely not least, is the personal obligation of the operator. A franchisee must devote 100% of their time to the operation of the business and in exclusivity to all else. However, it is very common that a licensee hold more than one licence at one time, often requiring 2 or 3 non competing product lines to earn a full income. The licensor has no control over the amount of time the licensee invests in the sale of its product. This is why performance standards are so important and accounts for the shorter term.
The terms “franchising” and “licensing” are used interchangeably by many when in fact they are polar opposites. I think they get confused because even in a franchise agreement the franchisor is still licensing the franchisee to use its intellectual property. Maybe it would all be clearer if we thought of the franchise agreement as already having a licensing agreement in it.