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US License v. Franchise: Be Careful!

Franchising in the US is a far more complicated and expensive affair than in the UK, a difference that both surprises and confuses small UK companies eagerly wishing to offer their business model to the massive American market.  On more than a few occasions I’ve heard of or dealt with such UK companies that stop in their tracks when faced with the expense and complexity of complying with US franchise regulations. 

Seeking to avoid such detailed regulations, some companies have opted to label their business opportunity a license instead of a franchise.  American casebooks are filled with tales of companies that have done just that and suffered severely for the mistake.   When doing certain business in the United States, it is vital to know the difference between a license and a franchise and to plan accordingly.

A licensing relationship is based almost exclusively upon use of property, usually intellectual.  The licensee pays a one-time fee to the licensor for the right to use the latter’s trademark, copyright, patent or other intellectual property, usually with some recurring royalty or lease payments.  While the licensor may require the licensee to use the intellectual property in accordance with certain limited rules, the licensor has no right to dictate, in any manner, how the licensee runs its business.  In other words, there is virtually no right of control by the licensor over the licensee’s business.

Control of business operations is the distinguishing feature of a franchise and if a licensor has any significant control over or provides assistance to a licensee’s business operations, then it is quite possible that the arrangement is a franchise rather than a license.  Such “disguised franchises” are a violation of federal and state law and carry penalties including fines, permanent bans on franchising, money damages for victims (including America’s notorious punitive damages) and in only the most egregiously fraudulent cases, jail sentences.  Not only the franchisor, but its officers, directors and managers who design, direct or control the franchisor’s operations may be subject to these penalties.

Control or assistance sufficient to deem a business a franchise typically include, but are not limited to:  approval of a business site or platform; requirements of site or platform design or appearance; designated hours of operation; prescribed production techniques; required accounting practices; required promotional campaigns; training programs; and, provision of an operations manual. 

While the upfront costs of franchising are far greater than those of licensing, they are, in the long term, probably less expensive and far more convenient.  Complying with various licensing and business opportunity requirements from state to state and from licensee to licensee can be an exercise in reinventing the wheel, each time accumulating fees.  On the other hand, the primary franchising document, called the Federal Disclosure Document, while very detailed and lengthy, is a one-time investment which can be tailored to the requirements of most states, leaving only state registration requirements to be satisfied.

Where a license is indeed the appropriate form of agreement, then proceeding accordingly is likely best.  However when there is doubt, then like so many other aspects of doing business in the USA, a little cautious planning can be the key to unlocking, and keeping, great rewards.