Two popular ways to get into running a business are through franchise and license agreements, both offering the benefit of allowing an entrepreneur to realise their goals through an established business model. Both types of agreements have different requirements in an operational and legal sense, which we’ll try and address in this article.
What are the basics of each type of agreement?
Franchise agreements: A franchise agreement is a legally binding contract between the franchisor (the established business owner) and the franchisee (the buyer), granting the franchisee the right to operate a business using the franchisor’s brand, products, and systems. In return, the franchisee pays initial fees and ongoing royalties to the franchisor.
The franchise agreement should cover matters such as the key terms of the business, training and support, non-compete clauses, how long the franchise relationship will last, royalty payments, renewal and sale rights, dispute resolution and a termination clause.
License agreement: A contractual arrangement between the licensor (the business owner) and the licensee (the buyer). The license agreement grants the licensee permission to use the licensor’s intellectual property, such as trademarks, patents, or proprietary technology, to operate their business. Unlike a franchise agreement, licensees usually have more independence in operating the business under license.
Typically the license agreement should cover the scope of the property being licensed, the agreed purpose for using the property, confidentiality clauses, exclusivity, payments or royalties, and any rights to transfer the license.
One of the key distinctions between a franchise and license agreement lies in the level of control and support provided by the original business owner. Franchises typically offer a higher level of support, as generally speaking the franchisor will provide comprehensive training, ongoing assistance, and a proven business model. In return the franchisee is also expected to adhere to specific guidelines and standards set by the franchisor, maintaining uniformity across all franchise locations in terms of factors such as business appearance, staff policies, and more.
License agreements, by contrast, tend to grant the licensee more autonomy in operating their business. While they gain access to the licensor’s intellectual property, the licensee will often receive limited other support and guidance. The licensee has the freedom to implement their own business strategies and practices as long as they stay within the terms of the license agreement.
Other key differences between franchising and licensing
When buying a business through a franchise agreement, the franchisee benefits from the established brand recognition and reputation of the franchisor. Customers are more likely to trust and frequent a business with a well-known brand, potentially leading to a faster return on investment.
License agreements, on the other hand, may not offer the same level of brand recognition, as the focus is primarily on accessing specific intellectual property. The success of the business largely depends on the licensee’s ability to market the product or service effectively under their own brand identity.
Franchise agreements will generally involve higher upfront costs than license agreements. In addition to an initial franchise fee, the franchisee is required to pay ongoing royalties to the franchisor, usually based on a percentage of their sales. These ongoing fees contribute to the support and resources provided by the franchisor.
License agreements often come with lower upfront costs, as they typically require a one-time licensing fee. The licensee may also negotiate a share of their revenue with the licensor, but this is usually less than the ongoing royalties associated with franchises.
Legal and regulatory requirements
Franchise agreements are subject to more stringent legal regulations compared with license agreements. In Australia, franchises are governed by the Franchising Code of Conduct, a mandatory regime that forms part of the Australian Consumer Law and which demands specific disclosure requirements, dispute resolution processes, and cooling-off periods for potential franchisees. This ensures transparency and protects the interests of both parties.
License agreements are generally less regulated, offering greater flexibility in their contractual terms. However, businesses should still seek legal advice to ensure that their licensing arrangement complies with relevant laws and regulations.
The importance of expert legal advice
Choosing between a franchise and a license agreement when buying a business requires careful consideration of various factors, including the level of support, brand recognition, costs, and legal requirements. Franchise agreements offer a turnkey solution with established support and a recognisable brand, but they come with higher costs and stricter regulations. License agreements, on the other hand, provide more independence and lower upfront expenses but may require the licensee to take on greater responsibilities for the business’s success.
Ultimately, prospective buyers must assess each agreement based on their individual preferences, circumstances, resources, and long-term business objectives to make an informed decision. At Felicio Law Firm our professional team regularly provide expert advice on the benefits and drawbacks of both franchising and license agreements, and can help clarify the issues involved for you, so contact us today.