If you’ve had success with your business, you may look to expand through a franchising or licensing agreement. But which is the better option? There are a number of considerations at play, but the answer largely depends on how much control you want to have over your brand – and as a wise man (Spiderman’s uncle Ben) once said, “With great power comes great responsibility.”
A licensing agreement is generally simpler than a franchising agreement. Through a licensing agreement, you grant permission to a licensee to use your intellectual property – often a trademark or patented technology – in accordance with guidelines laid out in the subject agreement.
Aside from (but within the scope of) those guidelines, the licensee is free to conduct business as they see fit. This can be an advantage if you have no interest in getting bogged down in the day-to-day operations of the licensee – but a disadvantage if you want greater control over “the details” and how your intellectual property is used.
Licensing agreements tend to cost less to set up than franchising agreements – and you’ll typically make less from licensing fees than you would from franchising fees. The licensee pays you licensing fees and/or royalties in exchange for the use of your intellectual property.
Similar to a licensing agreement, a franchising agreement gives a franchisee permission to use your intellectual property – but also to use your business model and supply chain, among other resources. Your role as a franchisor is far more hands-on; in a typical franchise arrangement, you can expect to assist franchisees with tasks such as marketing, training, management and other aspects of running the business.
Franchising agreements typically include prescriptive rules on how franchisees conduct business. This can be attractive if you want to have a high level of control over how your branding is being used, but you will also face greater responsibilities – and greater risks if you fail to comply with those responsibilities.
You’ll pay more to establish a set of franchising agreements and you’ll face a greater workload as a franchisor to get the franchise system up and running. The trade-off is that, once established, you’ll also have the opportunity to expand into and operate within new markets without doing all the legwork. Franchisees pay you a significant initial franchise fees to set up shop, as well as ongoing franchising and royalty fees.
Disclosure obligations and personal liability
In Western Canada, Manitoba, Alberta and British Columbia all have enacted specific legislation governing franchising agreements. Each of these provinces impose disclosure requirements on franchisors and offer statutory remedies to franchisees when franchisors have not lived up to their obligations.
Franchisors must provide comprehensive written disclosure to franchisees in the form and including the requirements set out by legislation that includes any material facts about their business and the opportunity presented. This is referred to as a “franchise disclosure document,” a “disclosure document” or an “FDD.” Legal counsel can help you prepare and compile this disclosure document, which is designed to help franchisees make an informed decision before investing in your business.
You may not experience any immediate effects if your disclosure is insufficient. But if a franchisee suffers a loss and discovers your disclosure was inadequate, they can pursue various remedies.
Among other things, a franchisee may seek recission of the franchise agreement within a prescribed period of time. This could void the agreement and require you to reimburse the franchisee for any fees paid to you, as well as the franchisee’s capital investments and losses. Your directors could also be held personally liable for recission claims, significantly increasing the risks associated with substandard disclosure.
Is your licensing agreement effectively a franchising agreement?
Another potential risk is entering into a licensing agreement that effectively operates as a franchising agreement – in which case, you’d be subject to the same potential liabilities as a franchisor.
Whether a “licensing” agreement is really a franchise agreement by any other name will be a question of fact. If you are found to have substantial control over the business operations of your licensee or you provide substantial assistance to the licensee, your arrangement may be viewed as a franchising agreement in the eyes of the law, regardless of your intention to act as a licensor.
If you have specific requirements vis-à-vis building location, training procedures and marketing practices for your licensees, your licensing agreement may effectively function as a franchising agreement. If you’re advising licensees on training their employees, helping them select a business location, offering assistance with marketing, etc., you could be subject to the same disclosure and legal requirements (and face the same risks) as a franchisor.
Furthermore, franchisees cannot waive their rights under franchise law. Even if your licensing agreement explicitly disclaims a franchising agreement, that won’t matter if you’re found to have substantial control over a licensee’s business or if you provide them with substantial assistance.
How MLT Aikins can help
Franchising can serve as a great way for you to reach new markets and increase the value of your brand while minimizing your workload and capital investments. However, it is important to go in with your eyes open. Franchising comes with significant and ongoing disclosure and oversight obligations, as well as substantial risks, that aren’t for every person or business.
If you’re considering franchising your business, the lawyers in our Franchising group have wide-ranging experience advising domestic and international clients on navigating the legal and regulatory requirements that apply to Canadian franchises. Contact us to learn how we can help.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.