Is Franchising the Best Method of Expansion?

Expansion Methods

Based on a company’s industry, operation and the controls and policies it wishes to dictate to individual locations, there are a number of possible expansion methods that a company may consider. The information provided in this section is a basic overview of four non-franchise expansion methods. It is not intended to be a full discourse or an opinion as to the options available to you. You should consult with your attorney or contact us for additional information.

Primary “Non-Franchise” Expansion Methods:

  • Corporate Expansion (company owned and operated locations)

  • Joint Ventures/General Partnerships

  • Limited Partnerships

  • Licensing (Distributorships/Dealerships)

Please review the outline below to learn more about these various expansion methods.

null

Licensing vs. Franchising

The chart below outlines the key differences between licensing and franchising. Scroll down to review additional expansion methods to determine which method is right for your business.

Elements of a License

Elements of a Franchise

License of a name and/or logo
License of a name and/or logo or “substantial association”with trademark
Payment of initial and/or ongoing license or royalty fees
Payment of initial and/or on-going franchise or royalty fees (at least $500 on or before the first 6 months of operation, exclusive of the wholesale price of a reasonable amount of inventory)
Licensor can “police” trademark (such as display of the mark or right of inspection) but cannot provide significant assistance to the licensee or significant control over the licensee.
Significant assistance to the Franchisee’s method of operation:
  • Formal sales, repair or business training programs;
  • Establishing accounting systems;
  • Furnishing management, marketing or personnel advice;
  • Selecting site locations; or
  • Furnishing a detailed operating manual
AND/OR
Significant types of control:
  • Site approval for unestablished business;
  • Site design or appearance requirements;
  • Hours of operation;
  • Production techniques;
  • Accounting practices;
  • Personnel policies and practices;
  • Promotional campaigns requiring the Franchisee’s participation or financial contribution;
  • Restrictions on customers; or
  • Location or sales area restriction
Licensee may purchase inventory from the Licensor at bona fide wholesale prices.
In addition to the above listed elements, the presence of any of which would suggest the existence of “significant control or assistance,” the following additional elements will, to a lesser extent, be considered when determining whether “significant” control or assistance is present in a relationship:
  • A requirement that a Franchisee service or repair a product (except warranty work);
  • Inventory controls;
  • Required displays of goods; or
  • On-the-job assistance in sales or repairs.
null

Which Expansion Method is the Right One for Your Business?

Corporate Expansion

Advantage:
  • Possible higher profit per location
Disadvantages:
  • Requires additional employees and an expanded hierarchy
  • Decreases ability to expand rapidly
  • Increases capital risk

Joint Ventures/General Partnerships

This method is basically a vehicle for aggregating capital and managerial/entrepreneurial skills. The owner gives up equity (and possibly control) to an entity which will be used to expand the business.

Disadvantages:
  • Not designed for businesses wishing to rapidly expand their distribution system using the capital and managerial skill of a large number of people.
  • Legally difficult, if not impossible, to create numerous joint ventures without being considered a franchise.
  • This method is typically used by companies which have limited expansion goals related to additional locations.
  • The joint venture must be the owner of the trademark used in connection with the distribution of goods or services, or have a royalty-free license to use the marks.
  • The joint venturers should not receive compensation from the venture other than as a profit participant or an employee.
  • All of the know-how, trade secrets, marketing plans and intellectual property used by the venture in conjunction with the distribution of its goods and services should be owned by the venture.
  • All of the joint venturers should be actively engaged in the management of the venture.
NOTE: These rules can vary by state.

Limited Partnerships

Two Major Requirements:
  • The owner of the intellectual property (i.e. the business system) must assume the role of the general partner and use the Limited Partnership solely to raise capital; OR the owner of the intellectual property must be willing to transfer ownership of the intellectual property to the limited partnership.
  • Limited partners are usually required to be passive investors.
NOTE: If careful consideration is not paid, the Limited Partnership may constitute a security and fall under the Securities Act of 1933.

Licensing (Distributorships & Dealerships)

Licensing is a common expansion method when the primary goal is increasing the lines of distribution related to the sale of the company’s products.
This expansion method differs from a franchise in the following respects:
  • May not charge a fee in excess of $500 prior to or during the first six months of operation as a condition of the licensee commencing operation of the business.
  • Distributors/Dealers are not authorized to operate the business using the company’s Trademark – they must operate under a different name. However, the licensee is permitted to state that they are “an authorized distributor/dealer of XYZ (company or product name).”
  • The Distributors/Dealers business must not be substantially identified with the trademark of the Franchisor.
  • Consideration should only be paid by Distributors/Dealers to the Company in the form of bona fide wholesale purchases of products from the Company – no additional fees should be charged (such as royalty or advertising fees).

Expansion Plan Includes

Corporate

Joint Venture

Limited Partnership

License

Franchise

Raise capital

-

YES

YES

-

YES

Add locations rapidly

-

?

-

YES

YES

Distribute additional products

YES

YES

-

YES

YES

License a "Turn Key" system

-

-

-

-

YES

License use of trademark(s)

-

-

-

-

YES

Specify operating procedures

YES

YES

YES

-

YES

Provide ongoing support

YES

YES

YES

-

YES

Provide advertising/marketing support

YES

-

YES

Minimal

YES

Provide sales assistance

YES

-

YES

-

YES