Understanding the legal differences between franchising and licensing
By Michael Seid, Managing Director, MSA Worldwide
On a flight the other day, I struck up a conversation with a fellow traveler, who happened to own a successful lawn care business. Being a consummate entrepreneur, I asked him about his business, and he proceeded to spend the next hour describing for me the world of lawn care.
Somewhere in between his telling me that you should never use your trucks to plow snow in the winter, and the likely cause of grass not growing under my willow tree, I was able to tell him that I was a franchise consultant. He had read my book Franchising for Dummies and now decided to spend the next hour and a half getting as much free franchise consulting advice as possible.
Marvin was an accountant by trade, but had gone into partnership with one of his clients in the lawn care business. New to lawn care, he proceeded to create what he described as a unique marketing campaign that was so successful that other lawn care providers in his area contacted him for advice.
Rather than give his advice away for free, he decided instead to subcontract his extra work to these competitors and split the gross profits. Over time his business continued to expand, but he began to receive complaints from customers about some of the practices his subcontractors used as well as the services they had delivered.
Working with a local writer, he created an operations manual for his business that contained forms, procedures, and standards he expected his subcontractors to follow. At first some of his subcontractors resisted his approach, but over time he was able to convince them that his methods were the best.
Prior to developing the manual, all of his subcontractors had been showing up for work in whatever work clothing they chose to wear, and drove trucks that had each of their individual company names on them. They also used different equipment and chemicals based on their own preferences. In the manual, he now required them to wear a uniform with his company’s name on it and to re-sign their trucks with his brand if they continued to work with him as subcontractors. Additionally, he required all of his subcontractors to use the same chemicals and sources for plants, and also arranged to have them buy the chemicals and other supplies from him at a discount based on his ability to order and store larger quantities. To pay for all of these extra services, he began to charge a monthly fee of $200 on top of the revenue split.
Marvin’s lawyer had recommended that as the next step in growing his company, he should consider developing a franchise system. It is at that point when he purchased my book. He was excited to tell me now that he believed his method of growth was far superior to franchising, since it involved fewer liability issues while also requiring significantly fewer legal fees.
He had decided, instead, to license his brand and his system to independent lawn care providers in towns around his area, but did not charge them a franchise fee. Instead, he charged them a single set-up fee of $2,500 and a monthly license fee of $500 for his buying-power services and advice. This way, he explained, he did not have to go through all of the hassles and expense of creating a Franchise Disclosure Document and investing in all of the costs necessary to build the infrastructure needed to support a franchise system. His lawyer told him it was a good alternative to developing a proper franchise system.
As gingerly as I could, I explained to him that he was already a franchisor and his only problem was that he had not done it legally. He resisted my explanation and definition of franchising at first, but finally came to realize that I was right and that he had a problem. I then walked Marvin through the issues of offering rescission to his licensees and how I would recommend he and his lawyer approach the process and the regulators.
Surprisingly, in the age of the Internet and with a library of articles on franchising available for free and books like mine sold in most bookstores, inadvertent franchising is not that uncommon. Franchising, after all, is something most lawyers never deal with, and understanding the differences under the law between franchising and licensing can be confusing. It becomes even more complicated when people think that the only definition of “franchising” they need to meet is the one defined by the Federal Trade Commission, not realizing that several states each have a unique approach to what legally makes someone a franchisor.
Undoing an inadvertent franchise can be complicated and expensive, depending on how happy the “licensees” are and the state they are located in. But if approached correctly, most regulators will understand that mistakes happen and are just happy to have someone tell them before they discover it themselves. While there may be fees and penalties to pay and sometimes the costs can be steep, getting back on track is the right thing to do.
I ended the conversation not certain if Marvin would be changing his approach, but made sure to give him the names of a few reputable franchise lawyers.
The lesson is that it is not sufficient to ask a general practitioner of the law about franchising. Franchising is not a subject covered in depth in most law schools, and is really a craft learned by lawyers and consultants who specialize in the field. Talking to a professional in franchising is critical – either a qualified franchise consultant, or a lawyer who is a member of the ABA Forum on Franchising or the International Franchise Association. Hopefully, Marvin will reach out to one of the lawyers I recommended to him and avoid some major headaches in his future.
~ Michael Seid