What's the difference between franchising vs. licensing a business? Is a license business model really different from a franchise business model? Whether you’re a franchise attorney or not, the starting point in any analysis is to consider the legal aspects, then the business aspects.
2. (1) Franchise disclosure-registration laws; and
(2) Business opportunity laws.
The thrust of these laws is to require sellers to give potential buyers enough pre-sale
information so informed investment decisions can be made before money changes
hands, contracts are signed and sizable financial commitments are undertaken. It doesn't
matter what terms are used by the parties in contracts or other documents to describe
their relationship. For example, the contract may call the relationship a license, a
distributorship, a joint venture, a dealership, independent contractors, consulting, etc., or
the parties may form a limited partnership or a corporation. This is entirely irrelevant in
the eyes of governmental regulators, their focus is not on semantics, but whether a small
number of defining elements are present or not. Today sellers are subject to a complex
web of regulations that differ from the federal level to the state level and even differ
widely from state to state. Murphy advises through Franchise my business.
DON’T FALL FOR TODAY’S SUCKER PLAY
The internet is filled with statements like “Compare high cost franchising to low cost
licensing.” Firms or individuals that say calling it a “license” dispenses with legal
regulations are delusional and wrong for at least three reasons:
(1) Common Sense - if it was really that easy, everyone would be doing it that way. The
3,000-plus companies that are franchising are not stupid. Many can afford the very best
legal talent available. It's not a coincidence they're all franchising and not licensing;
(2) Even if the relationship can be structured so it doesn't fall within the definition of a
"franchise," the backup regulatory protection mechanism - business opportunity laws
(discussed below) - will certainly apply. And complying with these is a lot more
expensive than going the franchise route; and
(3) Any analysis must include federal law (franchise and business opportunity) as well as
applicable state laws covering the same dual prongs (franchise and business
opportunity).
This all reminds me of some financial planners who still advise their U.S. clients that
filing U.S. income tax returns is not required under their interpretation of the U.S.
Constitution. It just doesn’t work that way. Actually it does work, but only until the IRS
catches up.
The "licensing avoids franchise regulations" spin (which, not surprisingly, is not
accepted in the legal community) also only works until the company gets caught. The
logic (not) goes something like this: licensing arises under contract law, not franchise
Franchise Foundations - 4157 23rd Street, San Francisco, California 94114 Ph: 800.942.4402
Page 2
3. law and therefore franchise law doesn't apply. Sound's just like the "you don't have to
file a tax return because tax laws don't apply" argument.
REAL LIFE EXAMPLES
A license attorney prepared a dealer license agreement and ignored the FTC Franchise
Rule disclosure requirements ("licensing arises under contract law, not franchise law").
The dealers became disgruntled and hired a litigation attorney who sued the company
for, not surprisingly, selling disguised illegal franchises. It cost the company $750,000 to
go to trial in federal court to answer the question "Is our license contract an illegal
franchise?"
"Is our license really a disguised, illegal franchise?" is always a very expensive question
to answer. Unless spending $750,000 is your idea of a good investment. Trying an end
run around the franchise disclosure laws by calling it a "license" or a "dealership" may
be a cheaper way to go initially. But it's only a question of when (not if) you will be
caught. Be prepared to spend mind-boggling amounts down the road when the disguised
illegal franchise is challenged for what it really is.
In a 2008 case, Otto Dental Supply, Inc. v. Kerr Corp., 2008 WL 410630 (E.D. Ark.
2/13/08) another disguised franchise vs. a license was at issue. The company claimed it
sold just a license, not a franchise and the franchise laws simply didn't apply. It made a
motion for summary judgment to have the case thrown out of court.
The federal Eastern District Court ruled against the company and ordered the case
forward. It said whether or not the license was really a franchise was up to a jury to
decide. Jurors are like most of us, and apply common sense to the simple defining
elements of a franchise. They are not swayed by semantic arguments like "licensing
arises under contract law, not franchise law and therefore franchise law doesn't apply."
Another very expensive franchise vs. license learning lesson.
And here's a final example. In Current Technology Concepts Inc. v. Irie Enterprises Inc.
the Minnesota Supreme Court concluded a licensing arrangement was a franchise and
held the franchise company liable for damages in the amount of $1.3 million for
violating the Minnesota Franchise Law.
Hearing "after the fact" that the arrangement was an accidental, illegal franchise and
you're liable for $1.3 million was the last thing that company ever wanted to hear.
Perhaps they got themselves into this mess by listening to statements found on the
internet that franchising is expensive and licensing inexpensive. Again, if something
sound's too good to be true, it usually is and this should be a big flashing red light.
Franchise Foundations - 4157 23rd Street, San Francisco, California 94114 Ph: 800.942.4402
Page 3
4. ROOTS OF LICENSING
It is important to remember the roots of licensing: artwork and character licensing -
where the owner (licensor) grants permission to copy and distribute copyrighted works,
such as allowing Mickey Mouse to appear on t-shirts and coffee mugs.
The most recent explosion in license law is the licensing of software on personal
computers. Or, the owner of a trademark allows another a license to use its mark as a
way of settling a trademark infringement suit. These are common and accepted forms of
licensing. However, the attempt to use licensing as an end-run around the franchise laws
is a corrupted use licensing was never intended for.
This is not to say licensing a business may be a viable option in foreign (out of U.S.)
transactions where U.S. laws don't apply - but these are a very small minority. Most
transactions and contracts cover U.S. activities and residents, so the franchise vs. license
question is usually an easy one to answer.
Author credentials and background
Kevin B. Murphy, Mr. Franchise, is a franchise lawyer based in San Francisco with a
30-year practice devoted exclusively to franchise law. For 20-years he has also been a
testifying franchise expert witness in court and arbitration proceedings, giving him vast
experience in knowing where the bullets come from in franchise litigation. For 17-years,
Mr. Murphy has been an Approved MCLE (Minimum Continuing Legal Education)
Provider by the State Bar of California, teaching franchise law, franchising vs. licensing
(franchise vs. license), and intellectual property courses to California attorneys. In 2002
-2003 he started, operated and sold a very successful franchise. Mr. Franchise holds
degrees in business administration and law from the University of San Francisco and an
MBA from San Francisco State University. He is the author of over 50 franchise
publications, including 4 books on franchising and one book on trade secrets.
Franchise Foundations - 4157 23rd Street, San Francisco, California 94114 Ph: 800.942.4402
Page 4
