Looking to expand your business? What’s the best strategy? License your trademark? Or franchise the entire business process? How do you distinguish between these two options?
The first step to making an informed decision about whether to grow your business by licensing or franchising is to understand the difference between the two legal structures.
What is a Trademark License?
Generally, licensing is a method of business expansion whereby one company, the “Licensor,” grants another company, the “Licensee,” the right to use a trademark in connection with the sale of products or services in exchange for a fee. For example, when Best Buy advertises and sells Apple iPhones, Best Buy will also obtain a license from Apple to use the Apple name (trademark) to advertise the sale of iPhones in its stores. This license agreement may include certain limitations as to how, for example, Best Buy can use the iPhone name, where Best Buy can use the name (e.g., only in its stores, in commercials, etc.) and how long Best Buy has the right to use the iPhone name. In exchange for this right, Best Buy pays Apple a fee.
When granting a license to use a name or trademark, the owner must keep control over the licensee’s use of the name in order to maintain quality control. Otherwise, the licensor may face a claim that it has abandoned the trademark and that the license agreement is actually a “naked” license.
However, the control exercised by the licensor must not be so great that the licensor actually exercises control over the operation of the business. If it does, the arrangement may actually be a franchise rather than a license relationship.
What is a Franchise?
Franchising is another method of business expansion. When thinking of franchises, most folks think of restaurants such as McDonalds, 7-Eleven or Pizza Hut. In fact, franchising crosses many industries including fitness, home health care, family entertainment centers such as trampoline parks, home improvement services, and tutoring services.
In a franchise relationship, the owner of the brand uses other peoples’ money and sweat equity to open additional locations under the same name. For example, Frank is a successful restauranteur. He has two hot dog restaurants named Frank’s Franks and he wants to open a third location. However, Frank does not want to invest his own money in the restaurant and does not have the time to manage yet another location. Instead, he allows his neighbor, Bob, to open a restaurant using the name Frank’s Franks. Frank teaches Bob how to operate the business as a Frank’s Franks restaurant in exchange for a monthly fee. This relationship is a franchise.
Similar to a trademark licensee, Bob, the franchisee, has the right to use Frank’s name “Frank’s Franks” to operate his restaurant. However, he is also obtaining the right to operate the restaurant as Frank’s Franks location. In exchange for these rights, Bob will pay Frank a fee.
Since Bob is going to operate the business as a Frank’s Franks restaurant (and not simply sell Frank’s Franks hot dogs), Frank will have to exert control over not only the use of the name but the operation of the restaurant.
Unlike licensing arrangements, the offer and sale of franchises is highly regulated by the Federal Trade Commission and the failure to comply with franchise laws, even inadvertently, can subject the franchisor/licensor to significant civil and even criminal penalties. Therefore, when creating a license relationship, it is important to make sure that a franchise is not inadvertently created.
What’s a Wannabe Licensor to do?
As discussed, under a true licensing arrangement, the licensor’s control over the licensee’s business operations is limited to the extent required to ensure quality control over the use of the trademark and the goods and services sold under the trademark. The licensor does not exercise control over other facets of the licensee’s business.
Thus, businesses that engage in licensing that do not want to fall within the rubric of franchising should be mindful not to exercise too much control over the licensee’s operations. Such activities, even inadvertent, may render the business opportunity a franchise and subject the licensor (and even its owners) to civil and potentially criminal charges for failure to comply with franchise laws.
In franchising, as in all business management, knowledge is power. Be informed. For more information on how to ensure your licensing arrangement does not cross the line into a more regulated franchise, let’s talk. Call (914) 265-4100.