The Difference Between Franchising & Licensing

John Pratt, senior partner at specialist franchise law firm Hamilton Pratt, explains the difference between franchising and licensing

What’s the difference between franchising and licensing? While that appears to be a very simple question, there’s no simple answer. The answers can range from ‘very little’ or they are like ‘chalk and cheese’. That sounds baffling, so let me explain.

A licence is granted when the owner of certain rights, such as know-how and trademarks, allows somebody to use those rights. The agreement to use these rights is described as a licence. Use is normally limited to specific purposes and a specific geographical area and in return for which payment is made to the owner of the rights, who is referred to as the licensor.

Quality control

Sometimes the licensor has the right to check the quality of goods produced or services provided using the licensor’s know-how or trademark.

This can be important because if the licensor itself is using the know-how and/or trademarks to off er similar goods or services as those to be off ered by the licensee, then if the licensee provides poor quality goods or services that will have a negative impact on the reputation of the licensor’s goods or services. It could also make it harder for the licensor subsequently to grant licences to others.

The more quality control a licensor imposes, the closer the licence agreement becomes to a franchise, which is an agreement in which the franchisor, as in a licence agreement, grants franchisees the right to use know-how and trademarks in return for payment and quality control compliance. A franchise agreement, however, does much more and those additional elements are important.

Significant difference

The first significant difference is that a franchisee is, in effect, required by the franchise agreement to hold itself out as being the franchisor (subject to safeguards to protect the franchisor from liability), which is not necessarily the case with a know-how or trademark licence, where the business can simply apply the trademark to certain products or services or make use of the know how for the purposes of its own products or services.

In a franchise relationship, because franchisees are, so far as the outside world is concerned, the franchisor, franchisors do impose very detailed obligations and restrictions on franchisees.

When you go for a McDonald’s, you don’t know whether the outlet providing you with the burger is a franchised or corporate outlet unless you look very carefully for the sign inside the outlet concerning ownership. That is because the franchisor has imposed obligations on franchisees to ensure the experience at a franchised outlet cannot be distinguished from a corporate owned one or other franchised outlets.

Further, no franchisor could allow a franchisee to do ‘bad’ things and thereby devalue everything they have built and also devalue the businesses established by other franchisees. As a result, franchise agreements contain numerous provisions to ensure compliance with what the franchisor expects of franchisees, which you do not find in licence agreements.

Successful system

Another fundamental difference is that a franchise is not simply the licensing of know-how and a brand. It’s much more, because inherent in the grant of a franchise is the franchisor assuring franchisees that the franchisor has developed a business that’s successful and which can be successfully replicated by the franchisee. This means that a franchisee who follows the franchisor’s system will be successful.

In a pure licence agreement, the licensor simply grants the licence and leaves it up to the licensee whether or not it’s successful. Franchisors have a very real and continuing interest in ensuring their franchisees are successful. Recruiting and training a franchisee is extremely expensive and the franchisor will have invested substantial resources in this process. The same is simply not true in relation to licences.

In this country the franchise units of the clearing banks often assist in the funding of franchisees. They have a substantial amount of information about the financial performance of franchisees and if an unacceptably high failure rate occurs, the bank will simply stop lending. No franchisor can afford, because of the need to fund most franchisees, a high failure rate.

Further, properly advised franchisees will ask a franchisor about the performance of its other franchisees when preparing projections of likely profitability. Therefore, a franchisor with a large number of poorly performing franchisees would be unlikely to be able to produce accurate projections positive enough to attract new franchisees.

These concerns don’t arise in a licence arrangement - each licensee will operate its licensed business in its own way and, therefore, the performance of others is simply not relevant.

Continuing relationship

Another major difference between a franchise agreement and a licence agreement is that there is a continuing relationship between the franchisor and franchisees in the form of updates to the operations manual, which franchisees are required to use and which contain the franchisor’s know-how.

There are also regular meetings, the provision of continuing guidance and advice and the offer of further training sessions. All of these elements are not usually found in licence agreements.

What does this mean? A detailed and prescriptive licence agreement can look very much like a ‘light touch’ franchise agreement, but generally a franchise agreement is a licence agreement on steroids.

It will be much more detailed - most UK franchise agreements are about 50 pages long because of the need for franchisors to ensure franchisees are successful and they comply with the requirements of the franchise system.

That is the big difference. A licensor generally is not overly concerned with the success of a licensee, but a franchisor has to have successful franchisees. That difference is reflected in how franchise agreements are drafted.