What’s the Difference Between Licensing and Franchising?

A licensing agreement allows the licensee to use, make and sell an idea, design, name or logo for a fee, whereas a franchise agreement allows the franchisee to operate a business as an independent branch of a company for a fee. And whether you sign a franchise agreement or a licensing agreement, you’ll have to pay a certain percentage of your sales back to the franchisor or licensor in royalties.

But there are also many differences between the two types of agreements, and legal oversight is one of the biggest.

Franchise agreements are governed by securities law while licensing agreements are governed by contract law. Often described as a “license on steroids,” the Federal Franchise Rule governs all franchise transactions throughout the U.S. and is enforced by the Federal Trade Commission. The rule requires franchisors to provide all potential franchisees with a disclosure document containing specific information they need in order to weigh the risks and benefits of a franchise investment. The Federal Franchise Rule defines a franchise as a company that meets the following criteria:

• Has a trademark, trade name, advertising or other commercial symbol the recipient can use in its business

• Provides significant assistance to the recipient in their business operations

• Charges a fee for their services

While a licensor may likely have one or two of those elements, if it doesn’t have all three, it’s not a franchise. And that means a licensing agreement is not governed by the FTC, but rather state contract law through a grant clause. If problems arise, remedy for a breach of contract would be resolved by the state where the contract was drawn, so it makes sense to check specific state laws, especially with regards to the statute of limitations.

Territorial rights are another thing to consider when debating between a franchise and a license agreement. Franchisors typically ensure that franchisees don’t cannibalize each other’s revenues, while licenses are usually non-exclusive, meaning they can be sold to multiple competing companies serving the same market.

Support and training is one of the hallmarks of most franchises, giving franchisees access to branding and marketing support, ongoing training programs, coaches, mentors and more. And with many of the elements and operations of running a business already in place, franchisees can often hit the ground running much quicker than they would if they were running their own business.

While licensees typically do not receive the same kind of training, counseling and support to ensure their success, they often enjoy a lot more freedom than franchisees. If you buy a franchise, you are bound to adhere to the operations and processes set forth by the franchisor, which in some cases can be overly controlling, harsh and punitive. If you purchase a license, your business operations will not be controlled by the licensor.

Whether you decide to become a franchisee or a licensee is often a matter of your personal preferences as a business owner. But in the end, the most important decision isn’t the type of legal agreement you enter into — it’s the company and the brand that will determine your success.