Franchises and licenses are both business agreements in which certain brand aspects are shared in exchange for a fee. However, a franchising agreement pertains to a business’s entire brand and operations, while a licensing agreement only applies to registered trademarks. Franchises typically work best for service-based businesses, while licenses are more conducive to product-based businesses. A licensee has more control over how they run their business compared to a franchisee, whose business will be dictated by the franchise owner (franchisor). However, a franchisee will also receive significant guidance and training from the franchisor.
While franchising and licensing have some similarities, they are two very different agreements that mean different things for both you and your brand. In this franchising vs. licensing comparison, we’ll explain the differences between the two, as well as the pros and cons of each.
What is franchising?
A franchise is a business agreement between a franchisor and a franchisee. The franchisor is the owner of a business. The franchisor sells the rights to their brand — including products and services, intellectual property and more — to a franchisee, who will open up a separate branch under that brand’s name, which is essentially a duplicate of the original business.
Franchises are regulated under the Federal Trade Commission’s franchise rule and must comply with state laws.
As part of the franchise agreement, the franchisee will pay fees to the franchisor to open a franchise, use their brand and for advice and business support. The franchisor loans their brand for a fee and provides training, as well as expertise, to the franchisee.
Franchising is a deeper, more complicated business relationship and agreement than licensing. A franchisor retains control over how their brand is used and how each franchise under their name is operated. There is a lot of interdependence between the franchisee and franchisor in a franchise relationship.
One of the most famous examples of a franchise is McDonald’s. From a modest start, the McDonald’s franchise now has more than 36,000 restaurants around the world.
Other famous franchise businesses include:
Ace Hardware Corporation.
The UPS Store.
Many chain restaurants and other well-known businesses operate as franchises. The key with franchises is that no matter which one you visit, it will always look and feel the same, offer the same products and services, and more.
What is licensing?
Licensing, on the other hand, is a limited, legal business relationship where a specific party is granted rights to use certain registered trademarks of a brand. The business relationship is between the licensor (the one who owns the trademarks) and licensee (the one who is granted rights to use them).
To use the registered trademarks of another brand, the licensee pays the licensor an agreed-upon royalty fee.
Two of the most famous brands that operate licensing agreements are Disney and Calvin Klein.
Calvin Klein works with a number of manufacturers under licensing agreements. This means that the Calvin Klein company has licensed, or loaned, its brand and trademarks to certain manufacturers who then use the brand to sell their products. Calvin Klein products such as underwear, perfume and jeans are all produced and branded under licensing agreements.
Using a recognizable brand name like Calvin Klein under a licensing agreement can help a lesser-known brand get their well-made product to the market and trusted by consumers faster than they would if they had to build their own brand from scratch.
Another example of a brand that uses licensing agreements is Disney. When you purchase items emblazoned with Disney characters, it’s most likely that the product wasn’t actually manufactured by Disney. More often, Disney signs licensing agreements with certain producers to use their characters and images, which is why you find Disney characters on everything from soap to sleeping bags to T-shirts and clothing.
In general, licensing agreements are most often used by brands that are highly recognizable and marketable. For a licensing agreement to be beneficial to both parties, the business branding must already be successful and known by a large portion of buyers.
How franchising vs. licensing differ
If you’re looking into franchise vs. license agreements, it’s probably because you’re looking into either building your business into a franchise business or loaning your brand to another company for use. Knowing the differences between these two business agreements is key before jumping into a legally binding agreement.
While some business owners may look at licensing as an easier alternative to franchising, this would be misguided. These two types of agreements are legally very different and are appropriate in different scenarios. Businesses that would make for good franchises would not necessarily make for good licensing agreements, and vice versa. Let’s take a closer look at how licensing and franchising differ.
One of the major differences when it comes to franchising vs. licensing is the limitation placed on licensing agreements. A license is much more limited than a franchise.
A license agreement allows for the use of registered trademarks, nothing more. Franchise agreements, on the other hand, allow for the use of trademarks, additional intellectual property, products, services, operating manual and much more.
Another difference between franchising vs. licensing is the amount of control that can be exerted by the seller over the buyer.
In a franchise agreement, the franchisor can lay out specific guidelines for how the franchisee markets the business, uses brand trademarks, where the business is located and how the business is operated. In other words, the franchisor can exert a significant amount of control over the franchisee’s business and how it operates — because it is essentially an extension of their own business.
In comparison, a licensor has very little control over the business of a licensee. The licensor can make stipulations on how protected marks are used by the licensee, but they can’t control any other aspects of the licensee’s business.
Type of business
Most often, businesses that grant or purchase licenses deal with products. Licenses are great for adding a well-known brand or image to a product, such as clothing or other consumer goods.
On the other hand, franchises are generally service-based businesses. Most businesses that form a franchise operation are chain restaurants, hotels, cleaning services, auto repair shops, software repair companies, etc.
In general, a franchise agreement is a much more stringent and complicated agreement. There are many moving parts within a franchise agreement, where a licensing agreement is a simple loan of certain protected marks or images.
In both instances, general contract law is followed for both licenses and franchises. In addition, there are specific federal regulations for franchises at the federal level and some additional requirements set down by certain states.
When starting a franchise, there are a lot more legal hurdles and regulatory requirements that must be followed than with a license agreement.
Pros and cons of franchising vs. licensing
Understanding the differences between franchises and licenses is only the first step in figuring out which is the right business model for you. It’s also beneficial to understand the benefits and drawbacks of both licenses and franchises.
One of the pros of becoming a franchisee is all the benefits of being a self-employed business owner without the risks of starting a new business. Franchises come with the bonus that they’re already a proven business model with a pre-established customer base. Purchasing a franchise is often much less risky than starting a business from scratch, and while there can be significant fees involved, they may amount to a smaller investment than if you were to build your own company from scratch.
Franchising also has the benefit of a shared relationship. The franchisor gets to scale their business rapidly while minimizing some of the work, which is instead done by franchisees. Additionally, the franchisee works with the franchisor to manage the business and learn business skills that they may not know already.
In comparison to licensing, one of the big pros of franchising is the depth of the relationship between franchisee and franchisor. The franchise agreement may be complicated, but it also provides a wide range of opportunities.
One of the drawbacks for a franchisee is the loss of control. While it’s your business, most of the major business decisions will be made, or at least must be approved by, the franchisor. While this support can be beneficial while learning the ropes of the business, it can also feel like being micromanaged to experienced business owners. However, this control is a pro for the franchisor, as they can still dictate how their brand is used.
In comparison to a license, a franchise will seem much more expensive and complicated. Initial franchise fees can cost between $10,000 and $50,000 — then there are the ongoing fees to keep in mind. This might seem exorbitant, but it’s important to remember that you’re getting access to an entire business. In comparison, a licensing agreement only gives you access to use specific trademarks in certain ways. So, a license will be cheaper and less complicated, but it also gives you access to a lot less.
Because of this cost discrepancy, business owners will sometimes opt for licensing agreements instead of franchising agreements; however, these are not interchangeable and often do not work for the same types of businesses. Not to mention, you’re also putting yourself at legal risk by forming a licensing agreement for business operations that actually fall under the franchising category. If initial fees are prohibiting you from starting a franchise, you may want to check out these low-cost franchise options, or you can also seek out franchise financing to help you fund these expenses.
One of the pros for licensing is the freedom for the licensee. In general, a license agreement happens between two established businesses. The licensee is purchasing the right to use protected marks that are already recognizable and appreciated by a built-in fan base. This makes licensing a secure investment and a great way to boost your business.
In comparison to franchises, another positive aspect of a license is the simplicity of the agreement. Because the license agreement covers the use of only one (or a few) protected marks, the agreement will be fairly simple and straightforward.
The major con of licensing over franchising is the limitations. A license only gives access to use certain protected marks, nothing more. While this makes the agreement limited, that might be all your business needs. It’s also important when entering a licensing agreement to ensure you’ve taken these steps to protect your intellectual property.
Another con of licenses is that many people don’t understand their true purpose. There’s a lot of confusion over when to create a licensing agreement and when the licensing agreement is broaching the legal boundary of a franchise. Be sure to check with a knowledgeable lawyer before signing either a licensing or franchising agreement.
Is franchising or licensing right for your business?
When deciding what’s right for your business and evaluating franchising vs. licensing, you have to consider the needs and goals of your business.
If you’ll be the franchisor or licensor, it’s important to consider whether your brand is strong enough, widely recognized and turning significant profits to the extent that it would do well either as multiple branches or emblazoned on products other than the ones you currently sell. If this is true and you run a service-based company, then franchising may be the right move. If it’s true and your company is product-based, licensing may be best. Either way, you’ll want to consult a trademark lawyer to protect your brand property, and then a business attorney to discuss the specifics of expanding your brand.
From the perspective of the franchisee or licensee, you need to think about where your business is within its journey. If you have a successful product-based business and are ready to grow, a license agreement with a recognizable brand could be an easy way to spur some quick growth. If you’re looking to start a business but prefer the lower level of risk an established brand offers, and are also looking for a hands-on mentor to guide you, a franchise is your best bet.
This article originally appeared on JustBusiness, a subsidiary of NerdWallet.