When is a licence arrangement not a licence arrangement? When it turns into a franchise. Ba boom. It sounds like a joke but it’s actually a serious question that even the savviest of business owners grapple with when establishing or growing their business.
If you’re looking to expand your business, you’ll need to carefully consider it too.
If you have a loyal customer base, consistently high demand for your product and the capital needed to pursue a successful expansion strategy, it’s time to choose the expansion model you’ll use to govern the relationships you have with your business partners. To licence or to franchise?
When looking for ways to expand your business, it’s easy to get confused between licence and franchise models. The terms are sometimes used interchangeably but there are important differences. What are the differences between the two strategies? What are the advantages and disadvantages of franchises? What regulations must you comply with as a franchisor or licensor? And if you have already entered into a relationship with a business partner, how do you know if it is a licence or franchise agreement?
There are advantages to both licence and franchise models of expansion, and which strategy you choose will depend on how your business operates and the level of control you want over your expansion and your business partners.
The Australian Competition and Consumer Commission (ACCC) has a rigid definition of what constitutes a franchise agreement, which means that, regardless of how you and your partners define the relationship, your business may be classified as a franchise and you may be subject to regulations under the Franchising Code of Conduct.
What is a licence agreement?
A licence agreement is a contract in which the licensor gives the licensee permission to use something without transferring ownership of it to them. Licence agreements are most often used for intellectual property, such as the licensing of a brand, logo or trademark.
Licence agreements are often considered a cheaper alternative to a franchise agreement because there are fewer upfront costs and less ongoing fees during the business relationship for the licensor. Licensees generally determine their own marketing strategies and systems for operating their businesses.
When Marvel’s Avengers: Infinity War hit cinemas, products relating to the superheroes started popping up everywhere, from Groot-shaped chopping boards to Infinity Gauntlet mugs. To produce this merchandise, Disney granted the licensees permission to use its intellectual property (the likeness of its superheroes) under a licence agreement. Now we can all have Rocket Racoon on our desks.
What is a franchise agreement?
A franchise agreement is also a type of contract, but it differs from a licence agreement by giving the franchisor more control over how the franchisee uses the franchisor’s property. Franchise agreements generally contain specific guidelines on how a franchisee must run its business.
Establishing a franchise system can be more expensive than entering into licence agreements, but franchise agreements give you greater control over how the franchisee operates. This allows you to roll out a common marketing plan across all franchises, monitor franchisee performance and dictate the exact methods the franchisee must adopt, including uniforms, location and shop fit out.
Think of the last time you had a Big Mac. Each McDonald’s restaurant is independently owned and operated by a franchisee but walk into any restaurant around the world and you know exactly what you’ll get – the same fit out, products, packaging and service. McDonald’s keeps its brand uniform by recruiting and training its franchisees and establishing explicit regulations for menu items, methods of operation, use of trademarks, and concepts for restaurant design.
How to determine if you’re in a licence or a franchise agreement
The ACCC has set key criteria for determining if your business arrangement falls within the definition of a franchise agreement. Your business may be classified as a franchise, even if you don’t consider yourself to be a franchisor.
To determine if you’ve entered into a franchise agreement, ask yourself the following questions:
- Is there a verbal, written or applied agreement between you and the licensee/franchisee?
- Has there been any payment (upfront or ongoing) for the provision of goods and services?
- Have you granted the licensee/franchisee permission to carry on a business?
- Is there a substantial system or marketing plan in place that you determined, suggested or control?
- Is your business substantially associated with a specific trademark or symbol?
All of these criteria must be met for an agreement to be classified as a franchise agreement. If you've answered yes to all of these questions, you’re most likely operating a franchise system and the Franchising Code of Conduct will apply.
What is a substantial system or marketing plan?
Even with this checklist, it is not always clear if your business arrangement is considered a franchise agreement. A common question is what does it mean to have a “substantial” system or marketing plan in place?
Australian courts have determined that the following behaviours push ‘licensors’ into franchise territory:
- Providing comprehensive advertising and promotional programs
- Retaining the right to screen and approve promotional materials
- Prohibitions on repackaging of products
- Requiring mandatory sales training programs
- Suggestions for retail prices charged for products
- Degree in which the franchisor assumes responsibility of centralised management and uniform standards regarding quality
- Auditing of books
- Inspection of premises
- Hiring of staff
- Establishing sales quotas and KPIs
- Requiring management training
- Use of standard forms prescribed by franchisor
- Requiring franchisees to submit a business plan
- Guiding or requiring details relating to funding and operation of the business to be included in this plan
What is the Franchising Code of Conduct?
The Franchising Code of Conduct is a mandatory code that governs the way that franchisors and franchisees conduct business with one another. The Code includes regulations for acting in good faith, proper disclosure of information, mechanisms for dispute resolution and procedures for ending a franchise agreement.
Even if the Code is inconsistent with the contract you have set up with your partners, as a franchisor, you are still legally obliged to comply. If you breach the Code, the franchisee may seek damages, or you may be hit with financial penalties from the courts.
Finding the right strategy for your business
The decision to enter into a licence or a franchise agreement will be based on a number of factors but the key factor is generally the level of control you want to maintain over your business partners.
If you want to expand but don’t want to take on the financial or operational responsibility of another business, a licence agreement may be the best strategy to pursue.
As a franchisor, you have more control over the branding and operations of your franchisee, but you are also subject to more obligations under the Franchising Code of Conduct and could be penalised for any breaches.
Remember that even if you and your business partners consider your arrangement a licence agreement, if you meet the key criteria, the ACCC will classify you as a franchisor and you must comply with the Franchising Code of Conduct.
If you’re unsure of how to classify your business relationship or need advice on what your obligations are under the Franchising Code of Conduct, get in touch with the BlueRock Law team. We’re here to help you grow your business in the most effective way while maintaining compliance.