Considering Licensing vs. Franchising?
While franchising is perhaps the world’s most powerful growth vehicle, the entrepreneur considering growth options would be well-advised to examine all alternative channels before committing to a particular growth strategy. In order to conduct this analysis, it is perhaps easiest to start with an understanding of the federal definition of a franchise.
The FTC defines a franchise as a business relationship that has three elements:
- The use of a common trademark;
- The provision of significant operational support or the exercise of significant operating control;
- The payment of a fee of over $500 in the first six months of operation. This definition includes initial fees, royalties, advertising fees, training fees, or fees for equipment. The lone exception is for goods sold to the franchisee at a bona fide wholesale price for resale.
If you structure a business relationship with these elements, it is a franchise, regardless of the name you give it. Take away one of these elements, and you have an alternative growth strategy. (Note:No discussion of these alternatives is complete without a brief word on state laws. In some states, a business only needstwo, not three of the definitional elements to qualify as a franchise. So be sure you are speaking with a qualified attorney when drafting your legal documents.)
Business Opportunities or Licensing
If you remove the name element of the franchise definition, you will create a business opportunities license (also called a Biz Op or a license). Essentially, a Biz Op is a non-branded franchise.
But the real concern for the entrepreneur considering the Biz Op route is that they will not be able to build and realize the value of a common consumer brand. This lack of a brand identity will put the licensor at a significant disadvantage when competing with franchisors that can use advertising to promote a common brand.
A second option for expansion is the use of a trademark license. In order to avoid qualifying as a franchisor, the trademark licensor will need to avoid the provision of significant operating control or assistance. Unfortunately, few of us own businesses where the name is so valuable that people would pay for it without paying for help in establishing the business itself. And it is extremely easy to step over this legal line in the sand.
And even if you could sell it, would you really want someone to use your namewithout the ability to control how they use it? A single rogue operator could destroy the brand that took you years to build.
The “No Fee” Options
The third way to avoid franchising involves removing the fee element from the equation. There are several ways in which this can be done.
All of these options share the common advantage of being less legally cumbersome than a franchise (with the possible exception of the Joint Venture, or JV), although all of them have their difficulties. Aside from the obvious loss of fee revenue, some of these disadvantages include a loss of control, potential increases in liability, the need to have a discrete product or service to sell, and, in the case of the JV, the need for a great deal more scrutiny of the expense side of the equation.
In making your decision, put the labels out of your head and focus on the structure best-suited for expansion of the business.
Legal definitions should never drive business decisions. Once you identify the expansion strategy that is most likely to maximize the value of your business model, you can then determine what legal framework will be required to formalize the relationships involved.