Definition of Licensing and Franchising

by Leslie Bloom; Updated June 06, 2018
Businessmen working together in office

If you are looking to grow your business, licensing and franchising are two options to consider. One allows you to replicate the business in another location, and the other permits people to distribute your products for a fee. Though they provide different ways to expand your business, both expose your products or services to a wider market and have the potential of providing more revenue for you. Both also come with downfalls that should be weighed before entering into a licensing or franchising agreement.

What Are Licensing and Franchising?

Licensing and franchising can be done both as a business owner and as someone looking to enter a specific market. If you are a business owner, you may want to license the use of your brand or products to another business in order to gain more exposure for your company and earn revenue on the side. If you opt to allow franchising of your company, it allows you to expand your business in places that you may not otherwise be able to reach.

Licensing. Licensing a product means you allow someone else to use your intellectual property, logo or design in exchange for fees. Those fees can include a lump sum, ongoing royalties or a percentage of the licensee’s sales. You are still associated with the product and have some control over how it is used. For example, you may license a T-shirt manufacturer to use your logo and branding only for their summer line during certain months of the year. The T-shirt manufacturer licenses your name and logo and agrees to your terms to help them sell their own products.

Companies strive to create brands, characters and celebrities they can license to other businesses. Licensing helps them increase their market share, drives consumer preference and loyalty for their artists and brands, maximizes exposure and increases sales revenue. Licensing provides the channel to do so without getting into businesses that are outside of their core operations. For example, Hannah Montana is a character/entertainer, not a greeting card publisher or clothing retailer. But companies such as Walmart are, and consequently will enter into licensing deals to sell items with that character on them.

When a business enters into a licensing agreement to use a celebrity, well-known characters or property, they become a licensee. A licensing agreement is structured to stipulate the terms and fees allowing the use of names and images on products. Using the images of TV characters, such as Hannah Montana or the Simpsons, or celebrities like the Jonas Brothers, to sell products requires a license. A computer manufacturer can obtain a license from Microsoft to include the company's software with their products, thus becoming a licensee.

Franchising. Franchising is a type of licensing that goes beyond use of a specific product or branding and encompasses your business model. Franchising allows another business to replicate your entire company and business model in exchange for fees. Those fees generally include a flat amount to join the franchise, along with ongoing royalties and other fees, including those for marketing or purchasing supplies and products through the franchisor. Generally, franchising is done by existing businesses with successful business models that want to expand their markets. Some examples of successful businesses that regularly expand using franchising include Jersey Mike’s, Yogurtland and Johnny Rockets.

By opening a franchise, a business owner gains instant brand and name recognition, employee training and advertising and marketing support. As a result, franchisees often stand a better chance of becoming profitable, increasing the odds for business survival. Big businesses are often both a franchisor and a licensee. For example, McDonald’s is a franchisor, selling franchise rights to qualified individuals to open McDonald's restaurants. McDonald’s is often a licensee to gain usage rights to images and characters from hit movies or television shows, such as Spiderman and SpongeBob SquarePants.

Licensing and Franchising Benefits

Both licensing and franchising allow you to increase income through multiple revenue streams at relatively little cost to you. In fact, both have other people marketing your product or service for you, and you are earning money while they're doing it. This allows you to enter other markets and gain exposure that you may not otherwise get.

Licensing is a good way to go if you have an established, recognizable brand and don’t want to open more – or any – stores. With licensing, you can expand your brand without investing in new locations or distribution channels. You can license to multiple users in multiple industries and earn usage fees, revenues and royalties from all of them. The best part is that there are typically no marketing or distribution costs for you. This is a cost-effective way to grow your brand with little time and financial investment.

Other benefits associated with licensing include:

  • Brand strength. When you license to other reputable businesses that align with your brand, you strengthen your brand message and position. It also increases awareness of your brand, growing its value.
  • New customers. Partnering with businesses in other industries can mean a lot of new, long-term customers for you. These are people who may have never been exposed to your product before.
  • Variety of markets. With licensing, you can explore a variety of markets that you may not have considered. It’s a good way to do customer research to see what works and to get creative with the type of companies who want to license your brand.

If you do want to expand the physical presence of your business, there are many benefits to franchising. A franchise allows you to expand your business and your brand without investing the resources or money to open a new store. With a franchise, the franchisee invests the resources to open a new location, but you retain control over how the store operates. As a franchisor, you provide ongoing support and participate in branding, marketing and training. This allows you to protect your brand and the quality of your product.

Other benefits associated with franchising include:

  • Risk allocation. The franchisee assumes the risks associated with opening and operating a store instead of the burden being on you.
  • Owner incentive. While an employee of your company may burn out or be unmotivated, a franchisee who purchases and operates his own business wants to see it succeed. A successful franchise means more revenue and brand loyalty for you.
  • Volume discounts. When you buy items in bulk, you generally get them for a better price. With a franchised business, you’ll need the same items for all of them to create uniformity, so suppliers may offer  volume discounts or rebates.

What Are Licensing and Franchising Agreements?

If you decide that licensing and franchising are right for you and your business, you’ll enter into a formal agreement for one or the other. Both licensing and franchising agreements are legal contractual obligations. However, franchises are governed by federal securities law, which adds another layer of protection and regulation that must be followed by all parties involved.

Licensing agreements are contractual rights for another company to use your intellectual property, and can be nonexclusive or exclusive. A nonexclusive license allows you to enter into licensing agreements with multiple parties, even if they are competitors. An exclusive license gives the licensee sole use of your brand or product, or the right to exclusive use in a defined market. You will be paid more by the licensee for an exclusive licensing agreement.

What you don't want to do is to enter into a licensing agreement with someone in the same industry as you, since you will then create your own competition. Instead, it's best to license to someone who is in a different industry altogether. If you already manufacture T-shirts, you don’t want to license your logo to another T-shirt manufacturer. But if a spa wants to make T-shirts with your logo to sell in their gift shop, that may be a viable option. Licensing agreements generally have fewer requirements than a franchise and are easier to finalize.

Franchising agreements can be more complicated since they are more highly regulated than licensing agreements. Generally, with a franchise agreement you provide your business name, products and services, and an entire proprietary system of operations to a franchisee. That includes training, quality control, marketing strategy and operations support. It even includes the look and feel of the physical store. The franchisee is then responsible for daily management of the location, which is considered an independently owned business even though it’s part of a larger franchise system.

Franchising agreements are generally exclusive to an area so that franchisees are not in competition with another. That doesn’t preclude two franchises from opening in the same city, necessarily, but the distance has to be great enough to support two of the same stores. Because a franchisee is responsible for bringing in revenue and paying royalties to the franchisor, he wants to ensure he has enough market share to make his investment worthwhile.

Licensing and franchising agreements should not be entered into lightly. After all, your brand and reputation are on the line. Make sure you are partnering with people who truly understand your brand and its value, and who will do what it takes to help your business succeed. Ensure that the terms of your agreement are fair and favorable to you and help you achieve your ultimate business goals and objectives.

Downfalls of Licensing and Franchising

Despite many potential benefits, licensing and franchising don’t make sense for every business. There are some downfalls of licensing and franchising that also need to be considered. The biggest downfall to licensing is that you lose a lot of control. While you can contract for certain things, you can’t control how the business you grant the license to operates, and you can't provide the type of oversight you would with a franchising agreement. Since your brand is at stake, make sure that you license only to reputable and reliable companies.

Franchising has its own downfalls as well. While you do retain a lot of control over the business model and operations of a franchise, you give up control of daily decisions. Those are made by the franchisee on your behalf. If the franchisee makes poor business decisions or has inefficient staff, it can negatively impact the reputation of your entire business. Another downfall to franchising is that you earn only a percentage of what you could make if you opened your own store. The franchisee is contracted to only share with you a certain amount of the gross profit or revenue. While this may still make sense if you don’t have the capital to invest in your own store, it’s something to consider.

If you are looking to expand your business or your brand, there are many options. Work with professionals who specialize in this area to help you determine what makes the most sense for you and your business. They can help you pick the best option and ensure that your licensing or franchise agreement is legally sound.

Video of the Day

Brought to you by Techwalla
Brought to you by Techwalla

About the Author

Leslie is a Los Angeles native with more than 20 years of experience writing for a variety of online and print publications. She has degrees in both journalism and law.

Cite this Article A tool to create a citation to reference this article Cite this Article