| What's the difference between franchising vs. licensing | | | | trap. They started out selling "licenses," operating under |
| a business? The starting point in the franchising vs. | | | | misguided advice, in a vain attempt to save money. |
| licensing a business analysis is to consider the legal | | | | Then, they either get sued for selling an unregistered or |
| aspects, then the business aspects. In considering the | | | | illegal franchise. Or they finally get competent legal |
| legal aspects, begin with the following premise that | | | | advice that what they've really sold are disguised |
| applies to both options. If you put someone into | | | | franchises, even though they were called a "license." |
| business (or allow them to use your business name | | | | The governmental agencies require them to offer full |
| mark) this transaction will normally be a regulated | | | | rescission rights (cancel the license, refund all money |
| activity, subject to substantial penalties for | | | | that's changed hands) to all persons they've sold |
| noncompliance. | | | | "licenses" to. Defenses like "we didn't sell a franchise, |
| This guiding legal principle, coupled with the business | | | | we only sold a license" or "it's a license and a license |
| aspects of selling a franchise vs. a license (discussed | | | | arises under contract law, not franchise law" just don't |
| below) will answer most franchise vs. license | | | | work and never have. In the end, they pay a lot more |
| questions. Advice from a competent franchise | | | | to have it done the way it should have from the very |
| attorney is indispensable. | | | | beginning. And for those disguised franchise owners |
| BACKGROUND OF FRANCHISE & BUSINESS | | | | who usually exercise their "let's get out of this license |
| OPPORTUNITY LAWS | | | | contract" rights given to them by the regulatory |
| Why does regulation exist? The government, due to | | | | agencies, the sellers end up putting them into the |
| documented past abuses where tens of thousands of | | | | business for free plus having to refund all the money |
| individuals lost all of their net worth by investing in | | | | they paid. Not a pretty picture. |
| nonexistent or worthless business endeavors, has | | | | STATE REGULATION OF FRANCHISING |
| devised two principal consumer protection | | | | Because regulation of franchising is at the federal and |
| mechanisms: | | | | state level, the effect of state regulation must also be |
| (1) franchise disclosure-registration laws; and | | | | considered. The FTC Rule sets minimum standards |
| (2) business opportunity laws. | | | | and applies in all states, unless a particular state sets |
| The thrust of these laws is to require sellers to give | | | | higher standards, and then that state's law applies. In |
| potential buyers enough pre-sale information so | | | | 1971, eight years before the FTC Rule went into effect, |
| informed investment decisions can be made before | | | | the State of California was the first to enact a |
| money changes hands, long-term contracts are signed | | | | franchise disclosure-registration law where a franchise |
| and sizeable financial commitments are undertaken. | | | | registration process is required before franchises can |
| Under federal regulations, a Franchise Disclosure | | | | be offered (i.e. advertised) or sold. The California |
| Document (FDD) covering twenty-three individual | | | | Franchise Investment Law was in response to a wave |
| chapters and a hundred or more pages in length must | | | | of consumer franchise complaints. Other states soon |
| be prepared and given to every potential buyer at | | | | followed California’s lead, leading to a situation |
| least 14 calendar days before any contract is signed | | | | where franchise companies had to follow different |
| or money paid. | | | | rules in each franchise registration state. |
| It doesn't matter what terms are used by the parties in | | | | To alleviate these difficulties and achieve a uniform |
| contracts or other documents to describe their | | | | format, a group of Securities Commissioners from |
| relationship. For example, the contract may call the | | | | various states adopted a Uniform Franchise |
| relationship a license, a distributorship, a joint venture, | | | | Regulation, effective in 1977, known as the Uniform |
| independent contractors, etc., or the parties may form | | | | Franchise Offering Circular (UFOC) format. All states |
| a limited partnership or a corporation. This is entirely | | | | requiring franchise registration followed the UFOC |
| irrelevant in the eyes of governmental regulators, in | | | | format, a thick document also containing 23 chapters |
| particular the Enforcement Division of the Federal | | | | of information. None of these states accepted what |
| Trade Commission (FTC). Their focus is not on | | | | was then known as the FTC's Basic Disclosure |
| semantics, but on whether a small number of defining | | | | Document. To ease the obvious predicament created |
| elements are present or not. Today the industry is | | | | by UFOC vs. FTC format, the FTC allowed |
| subject to a complex web of regulations that differ | | | | companies to use the UFOC format as an alternate to |
| from the Federal level to the state level and differ | | | | its Basic Disclosure Document. In 2007, the FTC |
| widely from state to state. | | | | adopted its own version of the UFOC format, known |
| Firms or individuals that say calling it a "license" | | | | as the Franchise Disclosure Document or FDD. The |
| dispenses with legal regulations are delusional and | | | | FDD format is the required format in all states |
| wrong for at least three reasons: | | | | beginning July 1, 2008. |
| (1) Common Sense - if it was really that easy, | | | | FRANCHISE BOX SUMMARY |
| everyone would would be doing it that way. The | | | | Bottom line on the franchise box: By preparing a single |
| 3,000-plus companies that are franchising are not | | | | franchise disclosure document (at a cost of about |
| stupid. Many of them can afford the best legal talent | | | | $30,000), a company satisfies the federal requirement |
| available. It's not a coincidence they're all franchising | | | | and is positioned to offer and sell franchises throughout |
| and not licensing; | | | | the United States. Although certain state-specific |
| (2) Even if the relationship is not regulated under | | | | information and disclosures may be required in the |
| franchise law, business opportunity laws (discussed | | | | minority of states having a franchise |
| below) will apply, and complying with these will be a lot | | | | registration-review process, this can normally be |
| more expensive than going the franchise route; and | | | | accomplished in a couple of extra hours per state. |
| (3) Any analysis must include federal as well as | | | | THE BUSINESS OPPORTUNITY BOX |
| applicable state laws. | | | | Now, let's consider the business opportunity box. At |
| This all reminds me of some financial planners who still | | | | the state level, there are approximately 24 states that |
| advise clients filing U.S. income tax returns is not | | | | regulate and register business opportunities. Unlike the |
| required under their interpretation of the U.S. | | | | franchise box, there is no such thing as a uniform |
| Constitution. It just doesn’t work that way. Actually | | | | business opportunity disclosure format. Business |
| it only works until the IRS catches up. The "licensing | | | | opportunity rules and registration requirements differ in |
| avoids franchise regulation" spin (which, not surprisingly, | | | | each business opportunity state. Many of these states |
| is not accepted in the legal community) also only | | | | also have a "cooling off" period, usually a couple days |
| works until the company gets caught. The logic (not) | | | | after the sale where buyers can change their mind for |
| goes something like this: licensing arises under contract | | | | any reason and receive a full refund. |
| law, not franchise law and therefore franchise law | | | | For a company that's going the business opportunity |
| doesn't apply. Sound's just like the "you don't have to | | | | route two different documents may need to be |
| file a tax return because tax laws don't apply" | | | | prepared and provided: the FTC's Basic Disclosure |
| argument. | | | | Document (if the business opportunity fits the |
| Here's a real life example. A "licensing attorney" | | | | FTC’s definition of a business opportunity) and a |
| prepared a dealer license agreement and ignored the | | | | state's more abbreviated business opportunity |
| FTC Franchise Rule disclosure requirements. The | | | | disclosure document. Also, different timelines may need |
| dealers became disgruntled and hired a litigation | | | | to be observed: the FTC's 14 calendar days before, |
| attorney who sued the company, not surprisingly, for | | | | and a business opportunity state's cooling off period |
| selling illegal, disguised franchises. It cost the company | | | | after. |
| $750,000 to go to trial in federal court to answer the | | | | Bottom line on the business opportunity box - if you're |
| question "Is this contract a franchise?" It's always a | | | | an attorney with a business opportunity or "licensing" |
| very expensive question to answer. Trying an end run | | | | client, get ready for hundreds of billable hours, you've |
| around the franchise disclosure laws by calling it a | | | | just landed a big one. But, if you're the business paying |
| "license" may be a cheaper way to go initially. But it's | | | | the legal bills, it's going to be a lot less money to go the |
| not a question of if you will be caught, the only | | | | franchise route. Prepare a single, Franchise Disclosure |
| question is when. Be prepared to spend mind-boggling | | | | Document, register in a state or two as expansion |
| amounts down the road when the disguised franchise | | | | efforts begin, and you're essentially done. |
| is challenged for what it really is. | | | | There are also other factors to consider in the |
| In a 2008 case, Otto Dental Supply, Inc. v. Kerr Corp., | | | | franchise vs. business opportunity analysis, including |
| 2008 WL 410630 (E.D. Ark. 2/13/08) another disguised | | | | liability issues (definitely a greater risk in the franchise |
| franchise vs. a license was at issue. The licensor | | | | arena) but these are beyond the scope of this article, |
| claimed it sold just a license, not a franchise and the | | | | which is not intended to offer legal advice. Companies |
| franchise laws didn't apply. It made a motion for | | | | should consult with competent, informed legal counsel |
| summary judgment to have the case thrown out of | | | | about the specifics of their particular situation before |
| court. The federal Eastern District Court ruled against | | | | making any decision. |
| the licensor and ordered the case onward. It said | | | | THE BUSINESS ASPECTS OF FRANCHISING VS. |
| whether or not the license was really a franchise was | | | | LICENSING A BUSINESS |
| up to a jury to decide. Juries apply common sense to | | | | The business aspects of the franchise vs. license and |
| the simple defining elements of a franchise. They are | | | | business opportunity options are relatively |
| not swayed by semantic arguments like "licensing | | | | straightforward. It all boils down to image from a |
| arises under contract law, not franchise law and | | | | marketing standpoint. From a credibility standpoint, does |
| therefore franchise law doesn't apply." Another | | | | your company want to stand toe to toe with the likes |
| expensive franchise vs. license learning lesson. | | | | of McDonalds, Radio Shack, H & R Block and |
| This is not to say licensing a business isn't a viable | | | | other franchised household names? These are the |
| option in foreign (out of U.S.) transactions where U.S. | | | | mental images formed in the mind when an average |
| laws don't apply - but these are a very small minority. | | | | consumer hears the word franchise, along with familiar, |
| Most transactions and contracts cover U.S. activities | | | | highly advertised slogans like "being in business for |
| and residents, so the franchise vs. license question is | | | | yourself, but not by yourself," "complete training," |
| an easy one to answer. Even inside the U.S. there are | | | | "support where and when you need it," etc. |
| some cases where calling the relationship a "license" | | | | This, coupled with the complete package of training, |
| makes sense. Years ago, a company selling education | | | | start up and ongoing support services offered by |
| franchises to university professionals called their | | | | franchise companies, makes a franchise a more |
| contract a license. To comply with applicable laws, a | | | | attractive commodity in the eyes of the prospective |
| full franchise disclosure document was prepared and | | | | buyer and an easier sale. The same applies to firms |
| registered. For strictly marketing reasons, the | | | | that first sold "licenses" then switched to selling |
| "franchise agreement" was called a license agreement | | | | "franchises." These companies report they attracted |
| within the franchise disclosure document. | | | | considerable interest and far more inquiries when |
| The list of required defining elements is quite short, and | | | | offering "franchises" compared to when they offered |
| although certain franchise exemptions and exclusions | | | | "licenses." So, even from a business standpoint, the |
| are available, the franchise statutory framework was | | | | franchising vs. licensing a business question is easy to |
| designed to pigeonhole these relationships into either a | | | | answer. In addition, and as discussed above, a "license" |
| franchise or business opportunity box. Normal license | | | | is almost always a franchise in disguise, a ticking bomb |
| agreements contain certain "control" provisions (right to | | | | creating significant legal issues if the FTC Rule (and |
| audit, require reports, mandate suppliers, etc.) and the | | | | corresponding state franchise registration laws) are not |
| presence of ANY control or assistance provision | | | | followed. |
| (operations manual, training, site or other assistance) is | | | | THE BUSINESS ASPECTS OF FRANCHISING VS. |
| enough to satisfy these elements of the Rule. In fact, | | | | BUSINESS OPPORTUNITIES |
| the title of the FTC Rule says it all: "Disclosure | | | | Business opportunity ventures, when compared to |
| Requirements & Prohibitions Concerning | | | | franchises, suffer from definite image problems that |
| Franchising and Business Opportunity Ventures." So, | | | | translate into difficult marketing issues. If you ever need |
| the focus must be on which box is better to use, not | | | | proof of this, just attend any business opportunity |
| on how to avoid using either box. | | | | show or expo. You'll see a host of fly-by-night |
| THE FRANCHISE BOX - REGULATION BY THE | | | | opportunities such as worm breeding in backyards, |
| FEDS | | | | exotic plants raised in glass bowls, condom vending |
| Let's consider the franchise box. Under FTC | | | | machines (not a bad idea these days) and the like all |
| regulations that became effective in 1979 a thick | | | | promoted by fast-talking, high pressure salespersons. |
| document (now called a Franchise Disclosure | | | | Does your company really want to be associated with |
| Document) must be prepared and given to | | | | these companies and the reputation they project? |
| prospective buyers for a minimum of 14 calendar days | | | | Poor image, coupled with the fact that business |
| before any money is paid or contracts are signed. This | | | | opportunity ventures typically provide little training and |
| document now contains 23 items or chapters of | | | | no ongoing support, make them a much more difficult |
| information, as well as current financial statements and | | | | sale to prospective buyers. In a business opportunity, |
| a copy of the actual contracts used. | | | | the buyer is just thrown a ball, and it's entirely up to |
| As mentioned, this document is designed to give | | | | them how to run with it. |
| prospective buyers enough pre-sale information about | | | | CONCLUDING REMARKS |
| the company, its financial condition, the proposed | | | | From both a legal and business perspective, the |
| contract, investment requirements, trademark rights, | | | | franchise vs. license choice is an easy one to make. |
| exclusive territories, etc.,so informed decisions can be | | | | Doing it right the first time will save money and |
| made before long-term contracts are signed. For | | | | significant legal headaches down the road. The |
| companies that attempt to disregard federal law, the | | | | individuals prevalent on the internet who claim (via very |
| FTC Act authorizes the Commission to recover civil | | | | unprofessional-looking websites) that merely calling the |
| penalties of up to $10,000 for each violation of its Rule, | | | | relationship a "license," are only selling a future lawsuit. |
| plus injunctive relief, consumer redress (obtaining | | | | They are not looking through the lens of an expert |
| complete refunds, canceling contracts), etc. Because | | | | with almost three decades of experience who has |
| each sale can involve multiple violations of various | | | | seen first-hand the havoc these "disguised" franchises |
| regulatory provisions, these fines can be substantial | | | | cause. Instead, they are attempting to make easy |
| and far outweigh the cost of doing it right the first time. | | | | money - at your expense. From the most basic, |
| Selling a disguised franchise (an illegal franchise) as a | | | | common sense perspective, if it looks like a Duck, talks |
| "license" can be the most expensive mistake a | | | | like a Duck and walks like a Duck - . . . it's a Duck. |
| company ever makes. One need only consult the | | | | © 1990-2009, Kevin B. Murphy, B.S., M.B.A., J.D. - all |
| franchise registration filings of various states to see | | | | rights reserved. |
| the significant number of companies that fall into this | | | | |