What’s the difference between franchising vs. licensing a business? The starting point in the franchising vs. licensing a business analysis is to think about the legal aspects, then the business aspects. In considering the legal aspects, begin with the following premise that applies to both options. If you place someone into business (or grant them to use your business name/mark) this transaction will normally be a regulated activity, subject to substantial penalties for noncompliance.

This guiding legal principle, coupled with the business aspects of selling a franchise vs. a license (discussed below) will answer most franchise vs. license questions. Advice from a competent franchise attorney is indispensable.

BACKGROUND OF FRANCHISE & BUSINESS OPPORTUNITY LAWS
Why does regulation exist? The government, due to documented past abuses where tens of thousands of individuals lost all of their net worth by investing in nonexistent or worthless business endeavors, has devised two principal consumer endorsement mechanisms:

(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 prefabricated before money changes hands, long-term contracts are signed and sizeable financial commitments are undertaken. Under federal regulations, a Franchise Disclosure Document (FDD) covering twenty-three individual chapters and a hundred or more pages in length must be prepared and given to apiece potential buyer at least 14 calendar days before any contract is signed or money paid.

It doesn’t matter what terms are used by the celebrations in contracts or other documents to describe their relationship. For example, the contract might call the relationship a license, a distributorship, a joint venture, independent contractors, etc., or the celebrations might form a limited partnership or a corporation. This is entirely irrelevant in the eyes of governmental regulators, in particular the Enforcement Division of the Federal Trade Commission (FTC). Their focus is not on semantics, but on whether a small number of defining elements are present or not. This day the industry is subject to a complex web of regulations that differ from the Federal level to the say level and differ widely from say to state.

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 would be doing it that way. The 3,000-plus companies that are franchising are not stupid. Many of them can afford the ideal legal talent available. It’s not a coincidence they’re all franchising and not licensing;

(2) Even if the relationship is not regulated under franchise law, business opportunity laws (discussed below) will apply, and complying with these will be a lot more costly than going the franchise route; and

(3) Any analysis must include federal as well as applicable say laws.

This all reminds me of some financial planners who still advise clients 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 only works until the IRS catches up. The “licensing avoids franchise regulation” 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 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.

Here’s a real life example. A “licensing attorney” prepared a dealer license agreement and ignored the FTC Franchise Rule disclosure requirements. The dealers became disgruntled and hired a litigation attorney who sued the company, not surprisingly, for selling illegal, disguised franchises. It cost the company 0,000 to go to trial in federal court to answer the question “Is this contract a franchise?” It’s always a very costly question to answer. Trying an end run around the franchise disclosure laws by calling it a “license” might be a cheaper way to go initially. But it’s not a question of if you will be caught, the only question is when. Be prepared to spend mind-boggling amounts down the road when the disguised 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 licensor claimed it sold just a license, not a franchise and the franchise laws didn’t apply. It prefabricated a motion for summary judgment to have the case thrown out of court. The federal Eastern District Court ruled against the licensor and ordered the case onward. It stated whether or not the license was really a franchise was up to a jury to decide. Juries 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 costly franchise vs. license learning lesson.

This is not to say licensing a business isn’t 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 an simple one to answer. Even inside the U.S. there are some cases where calling the relationship a “license” makes sense. Years ago, a company selling education franchises to university professionals called their contract a license. To comply with applicable laws, a full franchise disclosure document was prepared and registered. For strictly marketing reasons, the “franchise agreement” was called a license agreement within the franchise disclosure document.

The list of required defining elements is quite short, and even though certain franchise exemptions and exclusions are available, the franchise statutory framework was designed to pigeonhole these relationships into either a franchise or business opportunity box. Normal license agreements contain certain “control” viands (right to audit, require reports, mandate suppliers, etc.) and the presence of ANY control or assistance supplying (operations manual, training, site or other assistance) is enough to satisfy these elements of the Rule. In fact, the title of the FTC Rule says it all: “Disclosure Stipulations & Prohibitions Concerning Franchising and Business Opportunity Ventures.” So, the focus must be on which box is superior to use, not on how to refrain using either box.

THE FRANCHISE BOX – REGULATION BY THE FEDS
Let’s think about the franchise box. Under FTC regulations that became effective in 1979 a thick document (now called a Franchise Disclosure Document) must be prepared and given to prospective buyers for a minimum of 14 calendar days before any money is paid or contracts are signed. This document now contains 23 items or chapters of information, as well as current financial statements and a copy of the actual contracts used.

As mentioned, this document is designed to give prospective buyers enough pre-sale information about the company, its financial condition, the proposed contract, investment requirements, trademark rights, exclusive territories, etc.,so informed decisions can be prefabricated before long-term contracts are signed. For companies that attempt to disregard federal law, the FTC Act authorizes the Commission to recover civil penalties of up to ,000 for apiece violation of its Rule, plus injunctive relief, consumer redress (obtaining complete refunds, canceling contracts), etc. Because apiece understanding can involve multiple violations of various regulatory provisions, these fines can be substantial and far outweigh the cost of doing it right the first time.

Selling a disguised franchise (an illegal franchise) as a “license” can be the most costly mistake a company ever makes. One need only consult the franchise registration filings of various says to see the significant number of companies that begin into this trap. They started out selling “licenses,” operating under misguided advice, in a vain attempt to save money. Then, they either get sued for selling an unregistered or illegal franchise. Or they finally get competent legal advice that what they’ve really sold are disguised franchises, even though they were called a “license.” The governmental agencies require them to offer full rescission rights (cancel the license, refund all money that’s changed hands) to all persons they’ve sold “licenses” to. Defenses like “we didn’t sell a franchise, we only sold a license” or “it’s a license and a license arises under contract law, not franchise law” just don’t work and never have. In the end, they pay a lot more to have it done the way it should have from the very beginning. And for those disguised franchise owners who usually exercise their “let’s get out of this license contract” rights given to them by the regulatory agencies, the sellers end up putting them into the business for free plus having to refund all the money they paid. Not a pretty picture.

STATE REGULATION OF FRANCHISING
Because regulation of franchising is at the federal and say level, the effect of say regulation must also be considered. The FTC Rule sets minimum standards and applies in all states, unless a particular say sets higher standards, and then that state’s law applies. In 1971, eight years before the FTC Rule went into effect, the Say of California was the first to enact a franchise disclosure-registration law where a franchise registration process is required before franchises can be offered (i.e. advertised) or sold. The California Franchise Investment Law was in response to a wave of consumer franchise complaints. Other says soon followed California’s lead, leading to a situation where franchise companies had to follow different rules in apiece franchise registration state.

To alleviate these difficulties and achieve a uniform format, a group of Securities Commissioners from various says adopted a Uniform Franchise Regulation, effective in 1977, known as the Uniform Franchise Offering Circular (UFOC) format. All says requiring franchise registration followed the UFOC format, a thick document also containing 23 chapters of information. None of these says accepted what was then known as the FTC’s Basic Disclosure Document. To assist the obvious predicament created by UFOC vs. FTC format, the FTC granted companies to use the UFOC format as an alternate to its Basic Disclosure Document. In 2007, the FTC adopted its own version of the UFOC format, known as the Franchise Disclosure Document or FDD. The FDD format is the required format in all says beginning July 1, 2008.

FRANCHISE BOX SUMMARY
Bottom line on the franchise box: By preparing a single franchise disclosure document (at a cost of about ,000), a company satisfies the federal stipulation and is positioned to offer and sell franchises throughout the United States. Even though certain state-specific information and disclosures might be required in the minority of says having a franchise registration-review process, this can normally be accomplished in a couple of extra hours per state.

THE BUSINESS OPPORTUNITY BOX
Now, let’s think about the business opportunity box. At the say level, there are approximately 24 says that regulate and register business opportunities. Unlike the franchise box, there is no such thing as a uniform business opportunity disclosure format. Business opportunity rules and registration stipulations differ in apiece business opportunity state. Many of these says also have a “cooling off” period, usually a couple days after the understanding where buyers can change their mind for any reason and receive a full refund.

For a company that’s going the business opportunity route two different documents might need to be prepared and provided: the FTC’s Basic Disclosure Document (if the business opportunity fits the FTC’s definition of a business opportunity) and a state’s more short business opportunity disclosure document. Also, different timelines might need to be observed: the FTC’s 14 calendar days before, and a business opportunity state’s cooling off period after.

Bottom line on the business opportunity box – if you’re an attorney with a business opportunity or “licensing” client, get ready for hundreds of billable hours, you’ve just landed a huge one. But, if you’re the business paying the legal bills, it’s going to be a lot less money to go the franchise route. Prepare a single, Franchise Disclosure Document, register in a say or two as expansion efforts begin, and you’re essentially done.

There are also other factors to think about in the franchise vs. business opportunity analysis, including liability issues (definitely a greater risk in the franchise arena) but these are beyond the scope of this article, which is not intended to offer legal advice. Companies should consult with competent, informed legal counsel about the specifics of their particular situation before making any decision.

THE BUSINESS ASPECTS OF FRANCHISING VS. LICENSING A BUSINESS
The business aspects of the franchise vs. license and business opportunity options are relatively straightforward. It all boils down to image from a marketing standpoint. From a credibility standpoint, does your company want to stand toe to toe with the likes of McDonalds, Radio Shack, H & R Block and other franchised household names? These are the mental images formed in the mind when an average consumer hears the word franchise, along with familiar, highly advertised slogans like “being in business for yourself, but not by yourself,” “complete training,” “support where and when you need it,” etc.

This, coupled with the complete package of training, begin up and ongoing support services offered by franchise companies, makes a franchise a more captivating commodity in the eyes of the prospective buyer and an easier sale. The same applies to firms that first sold “licenses” then switched to selling “franchises.” These companies report they attracted considerable interest and far more inquiries when offering “franchises” compared to when they offered “licenses.” So, even from a business standpoint, the franchising vs. licensing a business question is simple to answer. In addition, and as discussed above, a “license” is nearly always a franchise in disguise, a ticking bomb creating significant legal issues if the FTC Rule (and corresponding say franchise registration laws) are not followed.

THE BUSINESS ASPECTS OF FRANCHISING VS. BUSINESS OPPORTUNITIES
Business opportunity ventures, when compared to franchises, suffer from definite image problems that translate into difficult marketing issues. If you ever need proof of this, just attend any business opportunity show or expo. You’ll see a host of fly-by-night opportunities such as worm breeding in backyards, exotic plants raised in glass bowls, condom vending machines (not a bad intent these days) and the like all promoted by fast-talking, high pressure salespersons. Does your company really want to be associated with these companies and the reputation they project? Poor image, coupled with the fact that business opportunity ventures typically wage tiny training and no ongoing support, make them a much more difficult understanding to prospective buyers. In a business opportunity, the buyer is just thrown a ball, and it’s entirely up to them how to run with it.

CONCLUDING REMARKS
From both a legal and business perspective, the franchise vs. license choice is an simple one to make. Doing it right the first time will save money and significant legal headaches down the road. The individuals prevalent on the world wide web who claim (via very unprofessional-looking websites) that merely calling the relationship a “license,” are only selling a future lawsuit. They are not looking through the lens of an expert with nearly three decades of experience who has seen first-hand the havoc these “disguised” franchises cause. Instead, they are attempting to make simple money – at your expense. From the most basic, common sense perspective, if it looks like a Duck, speaks like a Duck and walks like a Duck – . . . it’s a Duck.

© 1990-2009, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved.

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