Licensing and Franchising!

"I'd like to have owner-operators in my business, but I've heard franchising is complicated. Can I just use some sort of license instead?" I've heard this question, or comments with a similar sentiment, from many business owners over the years.

There is sometimes a prevailing view that a franchise structure is too difficult to establish and manage and that licensing provides a simpler alternative. In fact, the two models are quite different and serve different commercial purposes, so let's have a closer look.

Since the introduction of the Franchising Code of Conduct, some business owners have deliberately structured their business in ways that seek to avoid being "caught" under the Code. This is usually to avoid the compliance obligations and other perceived restrictions. A close look at the Code however, reveals that it is not particularly burdensome and creating artificial schemes to avoid those obligations is usually shortsighted. Besides which, the Code defines which businesses are captured by defining the characteristics of a franchise. So, whether a business model is called a license or partner arrangement ultimately has little relevance.

In simple terms, there are four key criteria the Code uses to determine if a business is considered to be a franchise.

Is it a Franchise?

In order to establish whether an agreement or arrangement is in fact a franchise, four elements need to be carefully considered:

1. The existence of an agreement

This first element is usually easily satisfied as the agreement doesn't necessarily have to be in writing; it may be wholly or partly a verbal or implied agreement.

2. The mark

Is the business operation substantially or materially associated with a trademark or commercial symbol owned, used or specified by the party granting the agreement?

3. Payment of a fee

The definition of a fee in this context is quite broad. Not only does it include traditional royalty payments or advertising levies, but it can include commissions, license fees, payment for goods and training fees. Payments also include situations where the franchisor receives money from clients, deducts fees and pays franchisees the balance regardless of whether or not such payments are detailed in the relevant agreements.

4. The existence of a marketing plan

Is there a system or marketing plan substantially determined or controlled by the franchisor? Unfortunately, the Code does not define either a "system" or "marketing plan" and clarifications in case law have been sparse. However, some indications were given in ACCC v Kyloe Pty Ltd [2007] and include:

• Detailed compensation and bonus structures for selling products
• A centralised bookkeeping and record-keeping computer operation
• Rights to screen and approve promotional materials
• Assistance in conducting opportunity meetings
• Suggestions for retail prices to be charged for products
• Comprehensive advertising and promotional programs
• Division of a state into marketing areas
• Establishment of sales quotas or targets
• Mandatory sales training regimes
• Provision of quotation sheets to the franchisee’s employees
• Provision of prescribed invoices and other sales forms to the franchisee
• Requirement that the franchisee gather information from customers for the franchisor and
• Restrictions on franchisee selling the franchisor’s products without consulting the franchisor

   

   

To avoid being captured by the Code, at least one of these four elements must be missing from the arrangement. Many businesses elect to not provide either a marketing plan or access to a trademark. However, this often has a significantly detrimental effect on the business. It is precisely these two elements which help drive demand for the franchise. Franchisees don’t want to have to build a brand themselves.

Neither do they want to spend the time, effort and expense of developing their own marketing plans. Prospective franchisees are interested in a franchise opportunity primarily because it provides the structure and guidance necessary for them to succeed.

Why would businesses remove these critical elements from their offer simply to avoid what are, in reality, relatively modest compliance requirements? Frankly, it doesn’t make sense. Doing so artificially limits the number and quality of franchisees willing to investigate the offer further. As a result, the business is likely to be starved of high quality operators. In turn, this will undoubtedly lead to lower levels of performance and stagnation.

The simplest, and frankly best, solution is for business owners to select the optimal model for the business and manage the resulting compliance issues in a cost-effective and efficient manner. Whether this optimal model is a franchise or license arrangement depends on many factors. For the sake of this discussion, those factors can be summed up in one key element for either party.

For the business principal, the key factor is control. Just how much control does the business principal reasonably require over the operation of the distribution network?

In a non-legal sense, the term “franchise” covers an extremely wide range of businesses and business formats. These vary from the highly controlled to those over which the franchisor exerts very little control. At the high control end of the spectrum, we have systems such as fast food giants McDonald’s and KFC — here, even the dialogue between customer and franchise is scripted and controlled — “would you like fries with that”. Such a high degree of control has its place and many businesses have grown remarkably by using a highly prescriptive business format franchise model.

At the other end of the spectrum, we have businesses that exercise little control over systems and processes. Banner groups are a great example. The banner group usually provides no guidance in terms of processes and systems, but does provide trademarks and a clear marketing plan and identity. These groups are often inaccurately called “licenses” when, in fact, they too are often actually franchises under the Code.

Both ends of the spectrum (and everything in between) have their place and can be highly successful — it’s a matter of selecting the right business model for the job.

Licenses are generally used to grant a right to use intellectual property in one form or another. Examples include:

• The provision of manufacturing technologies or techniques as in the case of Ampex which licensed its video tape recording technology to every VHS and Beta recorder manufacturer years ago
• Access to a trademark or know-how as in the case of the Heart Foundation — that organisation’s “tick” of approval is highly sought after
• Sales rights in a particular geographic or demographic territory as in the case of almost every international distribution arrangement

In franchises, the franchisor does indeed grant the right to use certain intellectual property. Certainly, that is a license. However, it’s the total package in which that license is offered which makes the distinction. And that’s probably the easiest way to think about the situation. Licenses are generally less comprehensive in their offer — they are basic and limited. Franchises tend to encompass a wider range of elements, offer more, and expect more in return.

What does this mean for me?

It’s important to understand the nature and implications of the business model you are contemplating. Franchising almost certainly means a higher degree of commitment for individuals — usually far more than a true licensed arrangement.

There is, however, one critical issue every prospective franchisee should consider. The Code requires franchisors to disclose certain information — information critical to understanding the nature of the arrangement and offer. There is no doubt that the disclosure requirements of the Code don’t ensure the franchisee is informed on every aspect of the offer, just the critical elements. It’s up to the individual franchisee to determine what other investigations and due diligence they should undertake.

But here’s the key issue for prospective franchisees. If you are contemplating entering into an arrangement with somebody who purports to offer a license, investigate it carefully. Ask yourself: is this arrangement truly a franchise by any other name? If so, ask yourself: what is the franchisor not telling me that I should know? Why is this franchisor attempting to avoid their reasonable obligations under the Code?

If there’s no reasonable explanation, and you are convinced the arrangement is a franchise by any other name, it may be wise to steer clear and find another opportunity.

Naturally, you should always seek legal advice from lawyers experienced in this area before entering into any contractual arrangements. Contact DCS Lawyers for your legal needs. 

Article by John Di Natale for Inside Franchise Business

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