Methods for Business Expansion [0:00]
Many business owners think about expanding their business, and there are several ways to do that. These include direct expansion, joint ventures and partnerships, licensing and franchising. Today, we will briefly discuss these different methods of business expansion, and in particular, we will focus on licensing and franchising as well as the differences between the two. When thinking about expanding your business into new markets, as I say, there are several business models to consider. The most common route is direct expansion whereby the company or business owner opens additional units or territories using its own resources. For example, a restaurateur who has a successful restaurant business may choose to open a second location, in which case they will lease another location, build out the restaurant, hire employees, and so forth. Another approach to business expansion is through partnerships or joint ventures where two business owners or additional individuals join together and pull their resources to develop and operate the business together. One caveat to this approach is, as we’ll discuss in a little bit, you want to be careful not to inadvertently create a franchise relationship.
More Details on Licensing [1:25]
Another option for business expansion is licensing. In this case, one company, the licensor will grant another company, the licensee, a right to use intellectual property for a limited purpose in exchange for a fee. This could be a trademark license, a technology license, or a license to use someone else’s patent. With a trademark license, the licensee is granted a non-exclusive right to use another company’s trademark or name in connection with the sale of certain products or services. For example, when Best Buy advertises and sells Apple iPhones, Best Buy will obtain a limited license from Apple to use the Apple name, its trademark, to advertise the sale of iPhones in stores. This license agreement may include and likely will include certain limitations as to how, for example, Best Buy can use the iPhone name or logo when advertising the phones.
In exchange for this right, Best Buy will pay Apple a fee. With a technology license, the licensee is granted a limited license to use the license or software. For example, many of us may have a license to use Microsoft 365 or an accounting software such as QuickBooks. There’s also such a thing as a patent license where the licensee is granted the right to use a patented process or technology. For example, someone invents a drug formula and obtains a patent. They will then grant a drug manufacturer a license to use the 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. Unlike franchising, which we’ll discuss next, the degree of control that the licensor or possesses over the licensee is limited to the underlying trademark or technology that is the subject of the license.
Franchising Pros and Cons [3:20]
Alternatively, some business owners choose to expand through franchising. Sometimes they have this plan in mind when they open their first couple of business locations. Other times what happens is successful business owners operating, say their restaurant or their gym, and a customer comes in or someone else comes in says, “Well, I love your concept, your coffee shop, your art studio, your fitness studio,” whatever it is, “And I’d like to open one in my town.” Or “I would like to implement your after school sports program or your home health care services program in my town.” That gets business owners thinking, “Hmm, maybe my business is right for franchising.” Generally, with franchising one party, the franchisee is licensed the right to use the franchisor’s trademark and method of operation in exchange for a fee. When we think of franchises, most folks think of restaurants, so McDonald’s or Pizza Hut, or we think of certain convenience stores such as 7-Eleven.
In fact, franchising crosses many industries including retail, hospitality, real estate, fitness, recreation and family entertainment, business services, household and home improvement services, healthcare, education, child care, pet services, printing, used clothing. The list goes on and on. There are lots of benefits to expanding through franchising. Business owners can achieve accelerated growth as they’re essentially using other people’s money and sweat equity to grow their business. In addition, it’s a way to grow your brand without the typical risk associated with the operation of a business location because it’s the franchisee, not the franchisor that takes on the business obligations such as the lease, the employment obligations, managing the day-to-day operations of the business. Those are some real benefits to expanding through franchising. Of course, there are some challenges to franchising. Operating a franchise is a very different business than operating your current business, and so the owner has to be prepared to really start to operate a new business.
The owner will also have to be comfortable letting go over some of the control of business operations because they’re licensing others the right to operate a business under their name with their method of operation. But the franchisee, not the franchisor, is going to control business operations. For business owners who really like to control operations, it may be difficult to let go a little bit. The franchise relationship is also highly regulated and the business owner, franchise owner, will have to invest time and money in establishing the franchise model before you can even offer a franchise. Business owners really want to think about whether they’re going to go franchising or trademark licensing.
Similarities and Differences Between Licensing and Franchising [6:20]
Now, we’re going to talk a little bit about how those two methods compare and how they’re different. Both trademark licenses and franchise relationships typically involve the license of a trademark or trade name, and the licensee of franchisee is going to have the right to use that name, either if it’s trademark license in connection with the sale of products or services or in a franchise in connection with, really, the operation of the business.
Both strategies can be used to expand a business and reach new markets, and they can provide opportunities to leverage a company’s brand, equity, knowledge and assets. But there are some key differences between the two. Let’s talk about those. With a trademark license, the right to use the trademark is limited to the use of the name in connection with the sale of the goods or services. It doesn’t include a business model or joint marketing program or anything of between the licensor and licensee. While a franchisee will also have the right to use the franchisors trademark or name, they often also have the right to use a business model or a system. The franchisee is getting the right to use more than simply the name of the business. In addition, under a license agreement, the licensor typically does not provide much by way of guidance and advice in business operations.
Whereas with the franchisor, we expect that the franchisor is going to provide support in areas like site selection, operations, training, marketing and so forth. If you’re going to be franchising your business, you’re going to likely wanted to teach the franchisees and give them guidance about how to operate a business. Whereas with a trademark license, you may guide the licensee in terms of how they use your name or your logo, but that’s going to be the extent of the guidance. Another difference between the two is really the amount of control that the license or a franchisor exerts over the business operations of the licensee or franchisee. A licensor really doesn’t control the licensee’s business. All they’re going to seek to control is how the trademark is used, how the logo is used, the font of the logo, the look of the logo where logo is placed.
But with a franchise, the franchisor is going to want to control the potentially the equipment the franchisee uses, the suppliers for equipment and products as well as how the franchisee uses the name. Really a franchisor is going to exert more control over the business operations of the franchisee than in a license arrangement. Let’s take an example. Let’s say Frank is a successful restaurateur. He has two hot dog restaurants named Frank’s Franks, and he wants to open a third. He’s deciding how he’s going to expand. Frank does not want to invest all his money in a third restaurant. He doesn’t have the time to manage yet another location. He needs to figure out how is he going to essentially authorize the operation of Frank’s Franks. If Frank has his neighbor or his friend Bob, who’s going to open up a Frank’s Frank, Frank can do that one of two ways, right?
He can do it as a trademark license, but in that case, Bob is just going to open up a restaurant using the name Frank’s Franks, and Bob is going to go about his business, create his own restaurant, come up with his own recipes and so forth, which is not really what Frank wants. Frank wants another Frank’s Franks location similar to the two he’s operating, in which case he’s going to offer Bob the right to operate a franchise. Bob is going to have the right to use the name Frank’s Franks, but Frank is also going to teach Bob how to up at the restaurant, share some recipes with Bob, help him with determining what inventory is required, where to get his supplies and so forth. In exchange for these rights, Todd’s going to pay Frank a fee.
Beware the Inadvertent Franchise [10:47]
It is important for business owners to make an informed decision as to whether they are looking to license their intellectual property or name or create a franchise, because unlike licensing arrangements, the offer and sale of franchises is highly regulated by the Federal Trade Commission and certain states and the failure to comply with franchise laws, even inadvertently can subject the franchise or license or to significant civil and even criminal penalties. Therefore, when creating a license relationship, it’s important to make sure that a franchise is not inadvertently created. The complexity of franchise laws means that a company may be franchising without realizing it.
The first question when expanding through licensing or a partnership, is to determine whether the relationship meets the definition of a franchise, because regardless of what you call it, if the relationship falls within the definition of a franchise, it’s a franchise. As they say, if it walks like a duck and quacks like a duck, it’s a franchise. Generally, there are three elements to the definition of a franchise. There’s the right to offer goods or services using the license or franchisor’s trademark. There’s a method of operation, maybe recipes or a system of operation or a joint marketing plan between the franchisor and franchisee, and there’s the payment of a fee by the franchisee.
But under some states statutes, such as New York, there’s only two elements to the definition of a franchise. Under New York law, franchise means a contact or agreement between two or more persons by which a franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by the franchisor and the franchisee is required to pay a fee, or, that’s the important point here, or the franchisee is granted the right to engage in the business of offering or selling goods or services substantially associated with the franchisor’s trademark and the franchisee is required to pay a fee.
It is important to understand that some trademark licenses are actually creating a franchise relationship because under a trademark license, oftentimes the licensee is given the right to use the trademark in the operation of a business or in connection with the operation of a business in exchange for a fee. It is also important to note that franchise sales laws are what we call consumer protection laws. They’re intended to protect the investor or the franchisee. To that end, most franchise laws have what we call anti-waiver provisions. The franchisee cannot even waive his or her rights under the law in a situation where the parties might, say, contractually agree that the relationship will be a licensing relationship rather than a franchise, it won’t serve to help the franchisor avoid franchise sales loss.
The next question is, “Well, what are the consequences of creating inadvertent franchise?” The problem with doing so is that before a franchise opportunity can be legally offered for sale, the seller must prepare a franchise disclosure document, which we refer to as an FDD. The FDD must include certain state and/or federally mandated information. In addition, in many states, the FDD must be registered with the state or notice must be filed with the state before the party sign an agreement or any amounts are paid to the franchisor or licensor. If the franchisor, licensor, fails to comply with these laws, consequences can include injunctions, civil penalties, even criminal penalties.
In addition, anyone who purchase a franchise without tiling receipt of the FDD may be able to bring a lawsuit against the seller for rescission and restitution. If the franchisee were to do so and be successful in a claim against the franchisor, the franchisor may be required to reimburse the franchisee for its entire investment costs. It’s really important that if a franchise relationship is created, that the franchisor comply with the laws, create the FDD, provide it to the franchisee before an agreement is signed or any money is received from the franchisee.
Questions to Ask Yourself if You Are Considering Franchising [15:15]
If you are considering franchising to expand your business, then there are some questions to ask yourself.
Really, the first question is your business franchisable, is a term we use. We’ve discussed this issue in a prior video, but generally some questions to consider and include, is your business unique? Do you have some trait that makes your business better than the competition? Do you have a secret sauce or a different marketing plan? Is your business easily replicated? Can you teach it to others? Is there a market for your product or service outside your territory? Do the profit margins make sense? Will a franchisee profit from the apparition of its business after factoring in the ongoing fee, it will pay to the franchisor? Because remember, not only does the franchisee have general operating expenses as you do when you operate your existing business, but they’re also going to be paying the franchise for fee, and there has to be enough revenue after that for the franchisee to bail it to profit from the business.
Have you ironed out the kinks? Do have a supplier network? Have you developed systems and operational guides, before really any expansion, whether it’s through a direct method or franchising? It’s really important to standardize the processes that you established at your original location in order to apply them to additional locations. This means outlining best practices for all aspects of your business, everything from inventory management to customer service. These are all some of the things to think about if you are thinking about franchising your business.
