Franchise vs License: What’s the Difference?

Forget dry theory and endless jargon, read on to understand the differences between license and franchise agreements and discover which business model is right for you.

All franchises involve licensing, but not all licensing agreements are franchises.

Confused yet?

When it comes to starting a business you might be tossing up between a franchise or license model. Although the two terms are sometimes used interchangeably, there are some key differences you’ll need to take into account.

If a new business has been on your radar, you’ll want to see how each of these arrangements are structured to help you find the best model for you.

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Class is in session.

How does licensing revenue work?

Let’s talk dollars and sense.

Licensing revenues, known as royalties, are laid out in a license agreement. 

The license agreement defines the limits and restrictions of the royalties, such as its geographic limitations, the duration of the agreement, and the type of products with particular royalty cuts. License agreements are uniquely regulated if the resource owner is the government or if the license agreement is a private contract.

In most license agreements, royalty rates are defined as a percentage of sales or a payment per unit. The many factors that can affect royalty rates include:

• Exclusivity of rights
• Available alternatives
• Risks involved
• Market demand
• Innovation levels of the products in question

To estimate royalty rates, the transactions between the buying and selling parties must be willingly executed. In other words, the agreement can’t be forced. Royalty transactions must also be conducted at arm's length, meaning that both parties act independently without a relationship.

The bargaining power of the two parties involved in a licensing agreement often depends on the nature of the product and/or services. 

Here’s an example of how that might look - Imagine Marvel Studios licensed the likeness of Iron Man or the Hulk to a toy manufacturer. Marvel would have more bargaining power because the manufacturer is likely to profit immensely from such an arrangement. This means Marvel has the leverage to take their business elsewhere if the manufacturer gets cold feet.

What is a franchise agreement?

A franchise agreement also includes a contract, but it’s different from a licensing agreement in that it gives the franchisor more control over how the franchisee runs their business.

Think of McDonald’s as an example.

Although each McDonald’s is run by individual franchisees, you’ll never find any variation in what a Big Mac looks like (or what’s inside). That’s because McDonald’s franchisees are contractually obliged to adhere to a franchise agreement with set parameters of how their business operates.

The system of franchising is an ongoing collaboration between legally and financially separate parties to market goods and services. Under this model, the franchisor grants franchisees the right, and imposes the obligation, to conduct a business in accordance with the Franchisor's concept.

In other words, no one who runs a McDonald’s franchise can switch out ingredients on the Big Mac any time soon (or ever).

Keen to learn more about how a franchise operates? Click here for the ‘Ultimate Guide to Franchises in Australia’

Franchise and license comparison

Which business relationship is right for you?

*Drum roll*

In truth, the answer is...“it depends”.

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.

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.

But if you’re looking to start your own business with a framework of support, then starting a franchise may be better suited to your goals.

What is a licence agreement?

A licensing agreement is a contract between two parties in which an asset owner (the licensor) permits another party (the licensee) to use an asset without transferring ownership.

This is most commonly seen in:

• Brands
• Logos
• Songs
• Technology
• Trademarks
• Intellectual Property

This agreement allows one party (the licensee) to use and/or earn revenue from the asset of the owner (licensor). At the same time, the licensing agreement also generates revenue - called royalties, for the licensor for allowing its copyrighted or patented material to be used by another company.

A licensing agreements will specify how licensed parties may use properties, such as: 

• The geographical regions where the asset can be utilised
• The time period parties are allowed to use the asset
• The exclusivity or non-exclusivity of an asset
• Scaling terms (e.g. new royalty fees incurred if the asset is reused a certain number of times)

Finally, licensing agreements are typically cheaper than franchise agreements because there are fewer upfront costs and less ongoing fees during the business relationship.