Find out which model is best for your business’s expansion by learning about the differences between licence and franchise for new growth opportunities or to re-model your existing business.
When is a licence arrangement not a licence arrangement? When it turns into a franchise. Ba boom. It sounds like a joke but it’s actually a serious question that even the savviest of business owners grapple with when growing their business.
If you’re looking to expand your business, you’ll need to carefully consider it too.
When you set up your franchise system you considered that you have a loyal customer base, consistently high demand for your product and the capital needed to pursue a successful expansion strategy. You went into franchising as the expansion model to govern the relationships you have with your business partners. Did you consider whether to licence or to franchise? Was the franchise the right model for you or could your adapt to a different growth strategy now?
Alternatively, you have a successful franchise model, but looking at other markets, either internationally or maybe smaller regional outlets, maybe a licence is more appropriate.
When looking for ways to expand your business, it’s easy to get confused between licence and franchise models. The terms are sometimes used interchangeably but there are important differences. What are the differences between the two strategies? What are the advantages and disadvantages of franchises? What regulations must you comply with as a franchisor or licensor? And if you have already entered into a relationship with a business partner, how do you know if it is a licence or franchise agreement?
There are advantages to both licence and franchise models of expansion, and which strategy you choose will depend on how your business operates and the level of control you want over your expansion and your business partners.
The Australian Competition and Consumer Commission (ACCC) has a rigid definition of what constitutes a franchise agreement, which means that, regardless of how you and your partners define the relationship, your business may be classified as a franchise and you may be subject to regulations under the Franchising Code of Conduct.
What is a Licence Agreement?
A licence agreement is a contract in which the licensor gives the licensee permission to use something without transferring ownership of it to them. Licence agreements are most often used for intellectual property, such as the licensing of a brand, logo or trademark.
Licence agreements are often considered a cheaper alternative to a franchise agreement because there are fewer upfront costs and less ongoing fees during the business relationship for the licensor. Licensees generally determine their own marketing strategies and systems for operating their businesses.
When Marvel’s Avengers: Infinity War hit cinemas, products relating to the superheroes started popping up everywhere, from Groot-shaped chopping boards to Infinity Gauntlet mugs. To produce this merchandise, Disney granted the licensees permission to use its intellectual property (the likeness of its superheroes) under a licence agreement. Now we can all have Rocket Racoon on our desks.
What is a Franchise Agreement?
A franchise agreement is also a type of contract, but it differs from a licence agreement by giving the franchisor more control over how the franchisee uses the franchisor’s property. Franchise agreements generally contain specific guidelines on how a franchisee must run its business.
Establishing a franchise system can be more expensive than entering into licence agreements, but franchise agreements give you greater control over how the franchisee operates. This allows you to roll out a common marketing plan across all franchises, monitor franchisee performance and dictate the exact methods the franchisee must adopt, including uniforms, location and shop fit out.
Think of the last time you had a Big Mac. Each McDonald’s restaurant is independently owned and operated by a franchisee but walk into any restaurant around the world and you know exactly what you’ll get – the same fit out, products, packaging and service. McDonald’s keeps its brand uniform by recruiting and training its franchisees and establishing explicit regulations for menu items, methods of operation, use of trademarks, and concepts for restaurant design.
How to Determine if You’re in a Licence or a Franchise Agreement
The ACCC has set key criteria for determining if your business arrangement falls within the definition of a franchise agreement. Your business may be classified as a franchise, even if you don’t consider yourself to be a franchisor.
To determine if you’ve entered into a franchise agreement, ask yourself the following questions:
Is there a verbal, written or applied agreement between you and the licensee/franchisee?
Has there been any payment (upfront or ongoing) for the provision of goods and services?
Have you granted the licensee/franchisee permission to carry on a business?
Is there a substantial system or marketing plan in place that you determined, suggested or control?
Is your business substantially associated with a specific trademark or symbol?
All of these criteria must be met for an agreement to be classified as a franchise agreement. If you’ve answered yes to all of these questions, you’re most likely operating a franchise system and the Franchising Code of Conduct will apply.
What is a Substantial System or Marketing Plan?
Even with this checklist, it is not always clear if your business arrangement is considered a franchise agreement. A common question is what does it mean to have a “substantial” system or marketing plan in place?
Australian courts have determined that the following behaviours push ‘licensors’ into franchise territory:
- Providing comprehensive advertising and promotional programs
- Retaining the right to screen and approve promotional materials
- Prohibitions on repackaging of products
- Requiring mandatory sales training programs
- Operations manuals:
Suggestions for retail prices charged for products
Degree in which the franchisor assumes responsibility of centralised management and uniform standards regarding quality
Auditing of books
Inspection of premises
Hiring of staff
Establishing sales quotas and KPIs
Requiring management training
Use of standard forms prescribed by franchisor
Requiring franchisees to submit a business plan
Guiding or requiring details relating to funding and operation of the business to be included in this plan
Finding the Right Strategy for Your Business
The decision to enter into a licence or a franchise agreement will be based on a number of factors but the key factor is generally the level of control you want to maintain over your business partners.
If you want to expand but don’t want to take on the financial or operational responsibility of another business, a licence agreement may be the best strategy to pursue. If you already have a franchise system but want to expand internationally, a licence arrangement might be the best model for you. However, you will need to consider the local laws before launching.
As a franchisor, you have more control over the branding and operations of your franchisee, but you are also subject to more obligations domestically under the Franchising Code of Conduct and could be penalised for any breaches.
Remember that even if you and your business partners consider your arrangement a licence agreement, if you meet the key criteria, the ACCC will classify you as a franchisor and you must comply with the Franchising Code of Conduct.
It is possible to run a franchise system and licence model, side by side, but you need to be clear on the rights and obligations of the parties, and practically how the relationship functions, to ensure what looks like a licence, is not actually a franchise.
If you’re unsure of how to classify your business relationship or need advice on what your obligations are under the Franchising Code of Conduct, please get in touch. We’re here to help you grow your business in the most effective way while maintaining compliance.