It’s no secret that the best type of idea is the one that continuously pays you returns without having to do additional work. It’s also no secret that the advent and proliferation of the digital age has created one of the greatest climates for idea generation and product creation.

With the generation of a great idea comes the possibility of licensing that idea. Many tech and retail companies have turned to this option as a viable business model for generating residual, passive income.

Licensing, at its foundation, is nothing more than granting someone else the right to utilize your intellectual property (idea, trademark, copyright etc.) in his/her regular course of business. True licensing is relatively straightforward and just requires the drafting of a legal document (“licensing agreement”) that outlines the terms of use that the person granting the license (“licensor”) grants to the party receiving the license (“licensee”).

However, many companies unknowingly enter into the realm of what has been deemed as the “accidental franchise”. This is where an intended license agreement actually has the legal affect of establishing a franchise.

Why is this bad? Franchises are highly regulated by state and Federal laws. In order to legally sell a franchise you must file certain paperwork with the FTC, and in certain jurisdictions, like in the case of Illinois, you have to file paperwork to meet state franchising laws. Selling a franchise, knowingly or otherwise, without filing the proper paperwork is a felony under federal law.

So how, in licensing your idea, do you make sure to avoid the accidental franchise? You look at these three factors that the FTC uses to decide whether a business relationship is a franchise.

  • Intellectual Property Element – this asks if there has been a grant of rights to use another’s business idea to offer, sell, or distribute goods or services;
  • Marketing Plan Element – this asks if the licensor is giving the licensee extensive amounts of assistance in or taking extensive control over the marketing, selling, or general operations of the licensee regarding the granted license; and
  • Franchise Fee Element – this asks if the licensee paid the licensor a required fee (at least $500) for the use of the intellectual property licensed.

Because factors “1” and “3” are almost always present when licensing, whether an agreement is actually a franchise usually comes down to the issue of control. When issuing a license it is important to remember that you, as a licensor, cannot exert control or give extensive assistance to the licensee in the selling or the offering to sell goods or services connected to the licensed intellectual property. This includes giving a marketing plan, setting territory restrictions, controlling payment, providing marketing material, providing training around the goods or service, providing inventory, etc.

As always, when entering into a legally binding relationship, consult an attorney who is knowledgeable in this area to help you draft documents that are sound and effectively avoid the accidental franchise.