An area I deal with a lot is the franchise versus license agreement. Though they share some similarities, they are very different legal devices.
What is a Franchise?
A franchise is a legal structure where independent owners can operate a business under the same brand and under substantial control of the franchisor. There are over 780,000 franchises in the United States! Generally there’s also proven systems and other intellectual property associated with the relationship.
What is a License Agreement?
A license agreement is when one party wants to use just the brand of another company. For example, if you want to sell Disney merchandise, you have to license that right from Disney. In that scenario, Disney isn’t telling you how to run your business, but they can still have control over how you display their intellectual property.
Substance Over Form
It doesn’t matter what you call it, even if both parties agree. If your relationship meets the elements of a franchise, you’re in a franchise relationship. This is only a problem because franchises require an absolute insane amount of regulation and due diligence.
The FTC has a three prong test to determine whether or not you’re in a franchise relationship. Firstly, are you operating under the franchisor’s brand? Secondly, do you pay $500 or more within the first six months? Finally, does the franchisor have substantial control over the franchisee?
Once the relationship meets the three prong test, it’s a franchise. There’s no exceptions to this rule. However, there can be greater requirements at the state level. If you franchise out your business, but you don’t follow the rules, the fines are enormous. We’re talking hundreds of thousands of dollars.
It’s important to get the right type of lawyer to set up a relationship like this. I’ve encountered way too many agreements called license agreements where they were accidentally a franchise. On top of the fines, the franchisees can also have rights to get out of the agreement if things go wrong.
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