License Agreement Explained
To begin with, in the most basic of terms, a license agreement is an agreement where considering a license fee, the licenor agrees to grant a license to the licensee for their use of the licensor’s intellectual property. It must be noted that the license agreement does not pass on any ownership rights of the licensed intellectual property to the licensee, but rather, authorizes the licensee to use the intellectual property of the licensor subject to the terms and conditions of the agreement. In other words, the licensor continues to own the licensed work and grants authorized use to the licensee.
A typical license agreement will generally cover the following issues: In addition to the above terms, a license agreement may also contain other terms such as those covering warranties, limitations of liability, scope of indemnification, termination, repurchase or return of the licensed work and other miscellaneous concerns. The actual license agreement, depending on the type of license, will often incorporate all of the above, and may also elaborate on several of the above issues.
Common types of license agreements include, among others, the following: There are also different ways to enforce a license agreement against the licensee. For instance, if a valid and binding license agreement is entered into by both parties, and the licensee breaches the agreement, then the licensor can sue the licensee for breach. However, if the licensee, who did not sign the license agreement, infringes upon the terms of the license agreement, then the licensor may be able to prove infringement of his rights if his license agreement was recorded with the appropriate governmental entity . For example, patents and trademarks may be recorded with the United States Patent and Trademark Office (USPTO), and copyrights may be recorded with the United States Copyright Office. For a license agreement enforceable against an assignment or sublicensee, it is thus important to record the license agreement with the appropriate governmental entity so that the licensee of an infringing licensee is deemed to have constructive knowledge of the license agreement. If the licensee has constructive knowledge of the license agreement, the licensee may be liable to the licensor for infringement of its rights.
Again, it also has to be noted that the right to exploit a patent, trademark or copyright does not pass onto a licensee in an assignment, only the right to use the intellectual property does. For example, licensing out of a business process to another party would be a case of assigning the process, while allowing a party to utilize aspects of the process such as manufacturing, delivery, marketing etc., but not providing the resultant procedure, may be a case of entering into an exclusive license agreement. It is also important to understand that a franchise, which has been developed using a new or existing business process, would require a license agreement between the licensor and the licensee so as to protect the relationships and to ensure that the licensee solely benefits from the business process. Thus, license agreements are an essential tool when, for example, developing a business process into a franchise system.
Franchise Agreements Analyzed
To appreciate the difference between a license agreement and a franchise agreement one must explore the workings of a franchise agreement. A franchise agreement is essentially the agreement with the franchisee with which the franchisor grants the rights to use its systems, brand/branding, and pre-established marketing materials in exchange for an upfront and/or ongoing fee. And while that is an oversimplification, it allows us to see the difference between the two types of agreements (that is a license agreement does not contain a continuing obligation to pay fees).
A franchise agreement will likely contain requirements to participate in training by the franchisor, contractually establish how the location or provider must advertise and market the goods and/or services it provides, and how to preserve the branding established by the franchisor. A typical franchise agreement will also include a provision providing the right of first refusal to open and/or purchase a location. Consider any major fast food chain: you go into the store and you see the same or similar types of marketing and goods or services being provided. You’ve basically seen the experience before. That is the power of a franchise agreement (and behind its costs).
Examples of some of the top franchises in the country:
Dunkin’ Donuts: Dunkin’ Donuts is a chain of coffee and doughnut shops that have become ubiquitous across the United States and around the world. The franchise model involves selling the rights to a business model that prioritizes speed, friendliness, and great coffee. To become a franchisee, you must meet Dunkin’ Donuts’ financial and operational requirements.
Kumon: Kumon is the world’s largest after-school math and reading program. The franchisee gets access to the program’s teaching materials, marketing tools, and support staff. Franchisees are also responsible for finding and leasing a facility and hiring the staff.
Differences Between License and Franchise Agreements
In essence, all franchise agreements are, in part, license agreements. However, it is the context and manner in which the contractual rights conferred by a franchise agreement or a license agreement are utilized that makes them either a valid franchise agreement or simply a license agreement.
The primary difference between a license agreement and a franchise agreement is the extent to which the license, and the right of use granted under a license, are regulated by legal requirements. Federal and state laws, such as the FTC Franchise Rule, govern the marketing and sale of franchises. State franchise laws further regulate the franchise relationship. The underlying principles of federal franchise regulation require franchisors to disclose the risk of operating a given franchise to potential franchisees prior to entering into a franchise agreement, and to provide a safe haven for their franchisees from wrongful termination or non-renewal. Some common state regulations include those that govern discrimination in franchise agreements; indirect or third party franchisor communications with franchisees; the expiration of franchise agreements; regulation of royalty fees; and protection against unfair or deceptive practices.
In contrast, most license agreements are not subject to these legal requirements. A license agreement is a private contractual agreement between the licensor and licensee, without involuntary, public disclosure requirements. The only requirements imposed by law are those that may require that a license agreement be in writing, contain particular terms and conditions, or be recorded to provide priority over other parties. While licensor and licensee do have certain common law obligations, such as the duty to perform in good faith, these obligations are not legislatively imposed and are mostly definitional.
The biggest differences between a license agreement and a franchise agreement are primarily those relating to control over how the business is conducted and revenue arising from the business. A licensor’s control over how the business is conducted by the licensee is limited whereas a franchisor generally has greater control over how the franchisee conducts business. This stems from the fact that the scope of licensing a trademark or a copyrighted material to a licensee is relatively limited. In licensing the use of a trademark,, the objective is to ensure that the marks are not diluted or tarnished through the licensee’s use of the trademark. In licensing the use of a copyrighted material, the objective is to ensure that such copyrighted material is not misused or stolen through the licensee’s use of the copyrighted material. This is the core function of licensing and the only areas over which licensors typically have control.
In contrast, the scope of control over how a business is conducted by a franchisee is considerably diluted where the agreement lacks an effective use of a trademark, copyright or patent to affect quality control over how the business is conducted. This is because core franchise operation standards, such as specifications and quality control over the manner, method and means by which a good is produced or a service is rendered, or even department management, are applied to ensure the consistency in how the business is conducted in various locations. Another distinction between a license agreement and a franchise agreement is that the franchisee generally pays a royalty fee rate based on a percentage of the franchisee’s gross sales whereas a licensee generally pays an upfront fee for the rights conveyed under the license agreement. The foregoing circumstances are typical engaging factors that help differentiate whether an agreement is a license agreement or a franchise agreement.
Advantages and Disadvantages of License Agreements
For a licensor, the advantages of a license agreement are generally to be able to expand the footprint of its activities with little or no investment, and to earn fees in return for the brand / know-how and other assets provided to the licensee. For the licensee, the principal advantage is a reduced expenditure on the purchase of technology and other know-how and goodwill, in return for an on-going right of access to it. Licensees may also wish to take a license as a precursor to making a full purchase.
Both licensor and licensee will need to be confident that the other is financially sound as a license, but the risks are obviously greater for a licensor because of the on-going involvement and connections after the deal is done. While they have more potential to suffer from faults or failures in the deal thereafter, licensees are much more common than franchises because they can afford greater risks (licensees usually have greater financial resources and can afford to absorb lower returns); they can form fully fledged corporations which may make it easier to fund them; and they can be incorporated on a local basismaking it less painful to remove failing franchisees.
Advantages and Disadvantages of Franchise Agreements
Franchise Agreements, like all other things, possess both advantages and disadvantages. The implications of these agreements should be evaluated before entering into a franchise agreement.
For the franchisor, the advantages of entering into a franchise agreement include the increase in distribution channels, which can result in greater reach and higher revenues. The franchisor has a loyal group of entrepreneurs to grow and sustain its brand. It doesn’t have to incur the costs related to carrying out the day to day operations of the business, which are handled by the franchisee. The franchisee incurs the cost of purchasing the supplies. The initial cost of entering into a franchise agreement is relatively low compared to the long-term potential for higher revenue stream that may result from the agreement. Also, as the franchise grows, it may have the opportunity to use the franchisee’s purchasing power to obtain lower costs of goods or services.
The disadvantages of entering into a franchise agreement for the franchisor include the continued obligation to maintain the integrity of the franchisor’s brand, while allowing the franchisee flexibility to operate its business. The franchisor may also be responsible for the conduct of its franchisee’s. Generally, the franchisor will not receive high revenues until the franchise entity is well established. And, the franchisor has the initial cost associated with developing an infrastructure for training the franchisee.
The advantages of entering into a franchise agreement for the franchisee include the ability to join an established business organization with proven capacity for making profits. The franchisee has the benefit of being able to offer sophisticated products or services that it does not have the resources to provide on its own. The franchisee is able to sell merchandise under a nationally recognized trademarks, allowing the franchisee to benefit from the goodwill of the established brand. The franchisee is also able to operate and conduct its business without having to spend money to create a business infrastructure. Additionally, the franchisee has the low cost associated with opening a new business, and the support of the franchisor, which includes start-up assistance.
The disadvantages of entering into a franchise agreement for the franchisee include the inability to take full advantage of employing new ideas that may exist in the business market. The franchisee may be required to adhere to operating and pricing criteria. The cost of entering into an agreement is high. If there is only one franchise of its kind in the region, then the franchisee is at a disadvantage as it is focused on one geographical location.
Deciding Between a License Agreement and a Franchise Agreement
Determining which type of agreement is right for your business will depend on a number of factors. Businesses should evaluate not only the financial aspects of each structure, but also how it meets the long-term vision of the business entities. Some things to consider: Industry Trends. The industry’s requirements for licensing or franchising may have an impact on the legal decision to be made. Is it common in your industry to license your intellectual property? Is it common to franchise your business? Are there state or federal regulations that require one structure over the other? How does your competition generally operate? Business Goals. With each type of agreement you may be essentially selling a portion of your intellectual property to others. If, for example, your business grows very large, you may no longer control the quality of the products or services that your licensee/franchisee provides. If that concern is very important to you, then a license agreement may be your preferred structure. Licensing agreements typically allow for more control over various aspects of your property, such as quality and presentation. Franchise agreements, on the other hand, are more likely to contain obligations to consumers, like required disclosures. A pure license agreement may not have those disclosure requirements. If you are interested in getting into certain international markets, you should also consider whether your trademark can be protected. The answer may ultimately help you decide between a license and a franchise and may even remove the choice from the process. Legal Considerations. Each industry will have its own legal considerations . For example, most franchisors are required to register their advertising materials with the state so that it can be reviewed by the government. This registration can take time. Moreover, if you want to make changes to your advertising after it has been registered, you may have to go through the registration process again. A license agreement may not require registration (although the advertising may be subject to some other review). Each state has its own requirements when it comes to licensing and franchising. Additionally, if you intend on selling franchises in more than one state, you may want to consider the legal obligations to franchise registration. Generally, franchises that are sold in other states are governed by the franchise laws of that state. Some states require franchises to register, others do not. The rules pertaining to registration can vary widely though, so make sure to have this fully evaluated. Finally, if you are dealing with any international entities, you should strongly consider working with someone familiar with protecting your trademark internationally. Different trademark rights exist throughout the world, and there are steps you must take to ensure protection of your mark in foreign countries. You should also consider how long it will take to get a trademark in a foreign country and at what expense. It might make sense for businesses to align this process with the decision between licensing and franchising. This is not intended to be a complete analysis of your specific business and whether a license or franchise agreement would be appropriate. For example, there are many other types of agreements that may fit your specific needs. An experienced attorney can help evaluate your options and help you move forward with the best strategy for your business.
Things to Consider Due to Applicable Law
When comparing the legal aspects of license agreements versus franchise agreements, the fundamental differences in these types of agreements also affect the obligations and requirements imposed by law. Licensing agreements impose fewer legal obligations on the parties, and do not impose a legal obligation on the licensor to disclose information to the licensee. Franchise agreements, however, impose a number of legal obligations on the parties.
Many jurisdictions have enacted franchise disclosure laws which impose obligations on franchisors to provide certain information to prospective franchisees in a prescribed form and in accordance with specific timelines. Failure to comply with these disclosure requirements can give rise to significant liability for the franchisor. License agreements do not include such legal disclosure obligations.
Franchise agreements are regulated by specific legislation (if enacted in a jurisdiction), and may require registration under state/federal franchise laws, or under intellectual property laws. Franchise regulators and intellectual property offices have substantial discretion in their licensing of franchise agreements, and may impose special conditions or obligations on the parties. If their conditions are not observed, a party may be found in breach of the franchise or intellectual property laws. License agreements do not contain such requirements.
Examples of Successful Licenses Compared Against Franchises
The best way to know the difference between a license agreement and a franchise agreement is to look at how they’ve each been used in successful, well-known businesses. Check out these profiles of the successful license agreements of Wrigley’s Spearmint and the successful franchise agreements of McDonald’s.
One of the most recognizable and successful franchises in the world has done it through MacDonald’s. McDonald’s has over 40,000 franchises all around the world. What gives McDonald’s the success it has is a model that has never strayed from its original food system. The system and the process of preparing food is the same process no matter where the store is. They practice consistency which establishes brand standards. Plus, McDonald’s also does an effective job at investing in their employees. They want the people who serve you your Big Mac to know not only how to make your burger but also how to handle your transactions, deal with upset customers, or handle any other issue that may arise. McDonald’s takes great pride in bringing their professional staff to their close-to-fired engine of fast food. That is why their brand represents one of the most successful and recognizable franchises in the world.
Not every success story is a huge chain like McDonald’s. With license agreements, it is more common that individual businesses license their intellectual property to others so that they can expand the brand and grow revenues. A prime example of how productive this is for small businesses is the Wrigley’s Spearmint Company, the company that owns Skittles, Juicy Fruit gum, and EatMints. One product they created on their own was Doublemint gum. Then they licensed the recipe to Chewingum, a Turkish producer. Now, companies in dozens of countries produce Doublemint gum. In fact, An article in a 1948 issue of Fortune magazine stated that Chewingum enjoyed such popularity that "many export markets were wiped out as U.S. distribution was taken over by Chewingum licensees."
Conclusion and Tips
In closing these details, and many others, distinguish a license agreement from a franchise agreement. Franchising is a complicated business model subject to a strict regulatory framework. While the retail sector considers franchising as a quick and easy answer to grow their brands, companies in other industries such as technology, manufacturing, distribution and even health care need to understand all the nuances of a franchising arrangement. What’s more, business arrangements such as agent, dealer or representative are considered distribution models for purposes of regulations and liabilities. It is crucial for a business to determine the type of business arrangement it is seeking to pursue, identify which items are really essential, and obtain the appropriate professional advice for the path to achieving its business goals . While a company could push ahead and proceed, the risks of getting it wrong have serious implications, and the consequences of failing to recognize and remediate franchising obligations can be devastating: unintended and disproportionate liabilities, early termination penalties, and rejected claims for non-qualification as a franchisor. Many companies believe they have too much at stake to consider a franchising arrangement. But, with the right guidance, understanding the differences will allow a company to spot the key issues that must be addressed and which will ultimately lead to a well-drafted licensing or franchising agreement which will stand them in good stead.