If you want to start a business and get a head start without having to reinvent the wheel, franchising or brand licensing may be right for you.
While both methods are popular among small business owners and entrepreneurs, they aren’t the same. Let’s look at the differences between franchising vs. licensing, their pros and cons, the costs involved in each business model and how to decide which one is right for you.
Franchising vs. Licensing: What’s the Difference?
Franchising is a method used by existing brands to distribute their products or services more widely. In a typical franchise structure, the franchiser establishes a brand’s trademark and business system while the franchisee pays a royalty for the right to do business under the franchisor’s name and processes.
Some franchising examples include fast-food chains (McDonald’s,) retailers (GNC,) logistics (The UPS Store,) urgent-care clinics (American Family Care,) commercial cleaning services (Jan-Pro), fitness centers (Orangetheory) and more.
Brand licensing refers to the establishment of a license agreement in which the original owner of a brand (the licensor) gives permission to a company (the licensee) to produce or market a product or service. The licensee can produce, promote, and distribute the product or service and, in exchange, the licensor will get royalties from the sale.
Some licensing examples include Starbucks, which licenses out its cafes in airports and bookstores, and Disney, which grants licenses to other companies to create products based on its trademarked characters.
Unlike brand licensing, which is a legal agreement limited in scope and only pertains to the use of a trademark or technology, franchising is a more involved business relationship. For instance, the franchisee is required to operate per designated systems and procedures as required by the franchiser.
One of the key differences between licensing and franchising is the amount of control involved. A franchiser retains a lot of power over its franchisees by supplying the business model, determining the territory of operation and enforcing the use of standardized marketing materials.
A licensor, on the other hand, sells the rights to use its products and trademarks in exchange for royalties, which are usually an agreed-on percentage of the licensee’s sales. However, the licensor doesn’t have control over the licensee’s business model or operations.
Franchising vs. Licensing: The Pros and Cons
A license is a limited legal agreement while franchising is a more extensive relationship that includes a franchise license. Here are the pros and cons of these 2 options:
The Advantages of Franchising
- You get the freedom and flexibility of self-employment while mitigating the risk of completely on your own by being part of a proven business.
- You can leverage a trusted brand name, a tried-and-true business model, proprietary information and an established operating system so you don’t have to reinvent the wheel.
- Thanks to a ready-made business plan, you can often get funding more easily. Also, some franchisers have their own financing arms to provide loans to franchisees.
- Most franchisers offer support to help you find a location, procure licenses, create a business plan, purchase equipment, etc., so you can get started quickly.
- Many franchises have a built-in customer base so you can start generating revenue right away. Some also have a dedicated sales team to help franchisees find clients without doing any selling on their own.
- Franchisors perform ongoing research and development at the brand level, taking the time and resources required for new product development off your plate.
- The initial investment for some franchise opportunities may be lower compared with starting a new business.
- Some franchisers limit the number of franchisees in each geographic region to reduce competition and ensure that each franchisee is getting enough business.
- You can choose from a diverse mix of products and services thanks to the many types of franchise businesses available in the market.
The Disadvantages of Franchising
- You don’t have much control over certain decisions as the franchisor controls many aspects of the business, such as pricing, marketing and operations.
- Some franchises require a high startup cost because you have to set up the business according to many specific requirements.
- Most franchising agreements are standardized, so there’s little room for negotiation.
- The profits can be slightly lower than if you own your business because you have to pay franchise fees.
- You have to go through a selection process with the franchisor. For example, you need to meet certain financial requirements, such as a minimum amount of liquid capital.
The Advantages of Licensing
- You can enter the market with lower risk and less capital because you’re leveraging the reputation of a known brand and a built-in customer base.
- A licensee has more liberty to create, improve and market a product to further increase profitability and market shares.
- You have more freedom to structure and promote your business than you would in a franchising model.
- There’s less risk in product development, market testing, manufacturing and distribution because you’re working with an established brand and production processes.
- Unlike franchising, you’re free to negotiate the terms of your contract.
The Disadvantages of Licensing
- Licensors typically don’t provide much support to licensees so you should have a well-established business system and resources to support the licensing deal.
- Many licensing agreements require a long-term commitment, some for as long as 15 to 20 years.
- Your ability to sustain the business and make a profit is dependent on the licensor’s brand reputation and intellectual property (IP), which aren’t under your control.
- A licensor can increase a renewal fee dramatically or decide not to renew a licensing agreement when the contract is up.
- There’s no guarantee of exclusivity in most licensing agreements so other licensees can enter the market, become your competitors and impact your profitability.
- Other licensees may inadvertently tarnish the reputation of the brand, which could then impact your sales.
- Licensors offer little, if any, product or brand research support to licensees.
The Cost of Licensing vs. Franchising
The costs of licensing and franchising vary widely depending on many factors.
According to the Small Business Administration, franchising fees typically range from $20,000-$50,000. You may be able to get started for less with some lesser-known brand or a home-based business model. On the other hand, expect to pay more to purchase a business franchise venture from a well-established brand or one that requires a large physical location, such as a hotel and full-service restaurant.
You’ll need to pay a monthly royalty fee, which is typically around 4% -12% of your revenue. You also may incur other franchising fees. For example, some franchisors may charge a marketing fee.
Besides, franchisors usually have minimum financial requirements for candidates. These often include your liquidity and net worth to make sure that you can stay afloat during the initial ramp-up phase until you’re able to turn a profit.
Brand licensing costs mostly involve paying royalties, which are usage-based payments made to brand owners for the ongoing use of their IP or assets. Sometimes licensees may pay an “all-in” cost to purchase a brand’s IP or assets instead of cutting royalty checks every month. This arrangement is less common but can benefit the licensee if the product turns out to be successful.
You should budget for hiring an in-house licensing department or external consultants to help you navigate the legalities of the licensing agreement and negotiate licensing fees. Unlike franchising, negotiation is critical because there’s no set royalty rate.
You also may need to commit to a minimum guarantee, which is the amount you’d pay the licensor regardless of the sales volume. It’s calculated based on predicted sales so it’s important that you project your sales accurately. Most licensors will ask for an advance of about 25%.
Franchising vs. Licensing: Which One is Right For You?
Both licensing and franchising have their pros and cons, so which one is better for small business owners and entrepreneurs?
Franchising: Get Started Without Reinventing the Wheel
Franchising is right for you if you want a “plug-and-play” business model with a proven record of success. You can expect more assistance in setting up the business and more ongoing support, such as training, product development and business system upgrade from a franchiser so you can focus on running your business. Some franchises even have a sales team to acquire clients and send them to franchisees.
If you’re new to running a business, franchising can give you the opportunities to learn the ropes without having to reinvent the wheel. You may also get an added sense of security as the franchisor makes all the corporate decisions and pays for expenses like accounting, marketing, advertising, etc.
Licensing: More Flexibility For Experienced Business Owners
However, franchising can be a long process and the typical franchise structure offers less flexibility. If you prefer a greater degree of control over your business, licensing may be a better option. The legalities of licensing are often less complex and have fewer requirements so you can get up and running faster.
If you have some experience setting up and running a business, licensing can give you more flexibility and room for creativity. The looser terms in a licensing agreement make it easier, quicker and less expensive to set up a business as a licensee. It’s also less cumbersome to terminate a licensing agreement if things don’t go as planned.
Choose an Option That Works For You
Other considerations include your personality and management style, how involved you want to be in the day-to-day management and operation of the business, your confidence in taking care of tasks such as marketing, as well as upfront investment and ongoing payments.
Whether you decide to enter a licensing agreement or purchase a franchise opportunity, make sure to do your research. Select a brand with a good reputation that can stand the test of time and a business approach that’s similar to yours. Also, do your due diligence to ensure that you understand the legalities of the agreement and get your funding lined up so you don’t have to worry about the deal falling through at the 11th hour.