For some businesses, the process of franchising seems too difficult and they would rather just license their brand and system through a license agreement.
The difference between a license and a franchise is important to consider when establishing business relationships. Otherwise, license agreements could be considered illegal franchises.
In general, a “franchise” is defined as-
1. Payment of $615 or more in the first six months to the franchisor or an affiliate;
2. Use of the franchisor’s trademark; and
3. Substantial assistance or control by the franchisor
All three of these elements are required to be considered a franchise under federal law. States with their own franchise laws may have varying definitions, but they generally mirror the federal laws.
New York has its own unique definition that requires either a “marketing plan” and a “fee” or to be “substantially associated with the franchisor’s trademark” and a “fee.” NY CLS Gen Bus § 681. Therefore, in New York, only a fee and one other element is required to be considered a franchise.
A license agreement therefore must eliminate one of the required elements of a franchise to avoid having to comply with franchise laws.
Any required revenue paid to the franchisor could satisfy the payment requirement. License agreements will typically require an initial fee, training fees, or royalty that most clients are not willing to forgo.
An express prohibition on using the licensor’s trademark would avoid the franchise requirements in most states. For example, each licensee uses their own business name, e.g., “Mary’s Subs,” “Bob’s Subs,” “Charlie’s Subs” etc. As a general rule, this type of business format is not an illegal franchise.
Or, a company may allow the use of a trademark, but not offer any significant control or assistance. Control or assistance can include requirements regarding the design or appearance of an outlet, training programs, or providing management, marketing, or personnel advice.
The major drawbacks to such arrangements are:
First, if the licensee is not using the trademark, the company is not building brand recognition or value to the goodwill of its mark.
Second, if the licensee is using the trademark, the company risks reputational harm to the goodwill of its mark by not providing assistance and maintaining uniformity among outlets.
Third, approximately 26 states and the FTC have varying “business opportunity” laws that require registration and disclosure that could apply to some licensing arrangements. Most states exempt franchises from compliance with business opportunity laws, which can be more burdensome than franchise laws.
Franchising is often the preferred path between compliance with business opportunity laws and Federal and State Franchise Laws because it allows the company to grow a quality brand.
If you already started licensing, do not worry, we can convert your licensing program into a franchise system in full compliance with the franchise laws.
If it is time to franchise your business or you are interested in learning more about franchising, schedule a consultation with one of our franchise attorneys.
