A franchise fee is what a prospective franchisee owes to the franchisor for the rights to use the franchise brand and franchise system. Typically the franchise fee refers to a one-time payment paid in the beginning of the relationship. But there are also ongoing franchise fees.
When you buy into a franchise opportunity, you gain valuable rights by contract. But you also have legal responsibilities. You must run the business according to the operations manual and the franchise agreement. You must also pay all required fees to the franchisor. Therefore, it’s very important to understand all fees.
What is a Franchise Fee?
In a broad sense, a franchise fee means any money that the franchisee pays to the franchisor in exchange for the right to operate a franchise business.
However, usually the term “franchise fee” usually refers to the initial fee. The Federal Trade Commission governs franchising legal requirements in the United States. Under the FTC Franchise Rule, this is called the “initial fee”.
Other typical fees are royalties and marketing / advertising fees.
Understanding the myriad of fees associated with franchising can be complex. Here’s a brief overview of the most common fees you might encounter in a franchise relationship:
| Type of Fee | Description | Typical Cost |
|---|---|---|
| Initial Franchise Fee | One-time payment for rights to franchisor's brand, logo, products, and systems. | $25,000 to $50,000 on average |
| Royalty Fee | Ongoing fees for continuous support; often a percentage of gross sales. | Around 6% on average |
| Marketing Fee | Contributes to the franchisor's national advertising and marketing fund. | 1% to 2% of gross revenue |
| Additional Fees (Variable) | These could be technology fees, audit fees, insurance, training fees, etc. | Varies by franchisor |
How do Franchise Fees Work?
Let’s explore these three main fee types to see how they work.
Initial Franchise Fee
The franchise fee is a one-time fee charged to prospective franchisees at the beginning of the business relationship.
Under the FTC Franchise Rule, the initial franchise fee is for goods and services received from the franchisor before the franchisee’s business opens. This fee covers intellectual property licenses including trademark and service marks. It will include the right to use the franchisor’s brand name, logo, products and systems. Typically, it is non-refundable.
The amount can be paid in one lump sum or spread out in installments. Example: $5,000 due upon application, $5,000 upon signing the agreement and $20,000 within 30 days of opening the business.
Initial franchising fees average $25,000 to $50,000. However, fees vary. Here are selected examples:
- Cruise Planners (an American Express Travel Agency) requires a $10,995 franchise fee.
- Another low-cost example is Subway, at $15,000.
- Panera comes in at $35,000 and McDonald’s at $45,000.
- Interim Healthcare charges $50,000.
- Mr. Handyman costs $59,900.
If you’re a military veteran you may get a special break. Hundreds of franchisors provide discounts off of the initial franchise fee to veterans, their spouses and even active military who are about to transition out of the military into business.
In most franchises, the initial fees are not a profit source. Rather, they are a way to cover costs to market the franchise, recruit new franchisees and compensate salespeople.
Royalty Fee
Royalties are ongoing fees. Royalties are designed to pay for ongoing support from the franchisor. A royalty fee has been likened to a membership charge to remain in good standing with the franchise.
Typically, royalties are a percentage of gross sales. This means, as gross sales go up the amount you pay will increase.
According to FranData, royalties have remained steady in recent years at around 6% overall.
However, that 6% average hides wide variations by industry. The lowest average royalties are 4.9% for the Photographic Products and Services industry. The highest royalties are for Business Related franchises, at 10%. Industry averages are just that — averages. For example, Liberty Tax Service charges a high 14% royalty! Make sure to compare costs in the same industry.
Also, it’s important to understand how the franchisor calculates royalties:
- Sometimes royalty percentages are based on volume. As your sales volume goes up, the royalty percentage may go down.
- Occasionally a royalty can be a fixed sum instead of a percentage. Franchisors like Fantastic Sams, a hair salon franchise, charge a flat royalty amount of roughly $360 per week. This can be a positive, because as revenues increase your fees do not increase. It can be a negative if sales go down.
Marketing Fees
Franchisees usually must contribute to the franchisor’s national advertising and marketing fund. The marketing fee helps advertise the brand you operate under. It may support specific types of marketing, too, such as online marketing.
The typical marketing fee ranges from 1% to 2% of gross revenue. Usually this amount is payable monthly.
Remember, national brand recognition is one of the advantages you get with franchise ownership. That brand advantage should make it easier for you to attract patrons into your local outlet. That is why most franchisors require franchisees to share responsibility for advertising and marketing costs.
How Do You Find the Fee Amounts?
The world of franchising is extensive, and the costs associated with it can be equally vast. If you’re considering buying a franchise, it’s essential to understand where to find all relevant financial information.
Primarily, this information is housed in the Franchise Disclosure Document (FDD), a mandate by the Federal Trade Commission’s Franchise Rule.
Not only does this rule ensure transparency, but it also makes it incumbent upon the franchisor to furnish the FDD to every potential franchisee.
While you might find some snippets of information on a franchisor’s website or promotional brochures, it’s the FDD that will give you the comprehensive financial layout.
Franchise Fee vs Initial Investment – the Same?
While these terms might sound similar, they serve different purposes in the franchising world. The franchise fee is typically a one-time upfront cost that grants you the license to operate the franchise.
However, the initial investment encompasses a wider range of expenses. As required by the FTC Franchise Rule, franchisors should delineate a detailed breakdown of the total initial investment in an organized tabulation.
This comprehensive figure includes but isn’t limited to initial stock, rent, security deposits, branding essentials like signage, initial training, and any other foundational expenses.
Evaluating the True Cost of Owning a Franchise
Owning a franchise involves more financial commitment than just the initial franchise fee. To fully grasp the extent of your investment and its implications on your financial future, it’s crucial to evaluate all associated costs thoroughly. Here’s how to dissect the true cost of owning a franchise:
- Ongoing Royalties: Most franchises charge a recurring royalty fee, which is typically a percentage of your gross sales. This fee compensates the franchisor for the continuous use of their trademark and support services. Understanding this fee’s impact on your revenue is vital for financial planning.
- Marketing Fees: Many franchisors also require contributions to a national or regional marketing fund. While this fee ensures your business benefits from broad advertising efforts, it’s another cost that affects your bottom line. Assess how these fees are managed and what direct benefits they offer your specific location.
- Operational Expenses: Beyond the franchise-specific fees, operational costs such as rent, utilities, payroll, inventory, and insurance are fundamental to your business’s day-to-day running. These costs can vary widely based on your franchise’s location, size, and industry.
- Capital Expenditures: Initial setup costs for a franchise can be substantial. These may include expenses for fitting out your business premises, purchasing initial inventory, and acquiring any necessary equipment. Some franchisors offer financing options for these expenses, but they will ultimately influence your startup budget and financial projections.
- Legal and Professional Fees: Engaging a lawyer to review your franchise agreement and a financial advisor to help with business planning incurs costs. However, these professional services are crucial for navigating the complexities of franchise ownership and should be factored into your initial investment.
- Training and Support Fees: While the initial franchise fee often covers training costs, there may be additional charges for ongoing support, refresher courses, or attending annual conferences. These costs contribute to your franchise’s operational efficiency and compliance with brand standards but also add to your expenses.
- Renewal and Exit Costs: Consider the long-term costs associated with renewing your franchise agreement or exiting the franchise. Renewal may require additional fees or investments to update your premises, while exit costs can include fees for transferring or terminating your agreement.
By carefully evaluating these costs and incorporating them into your financial planning, you can develop a realistic understanding of what it truly costs to own and operate a franchise. This comprehensive approach ensures you’re not just financially prepared for the initial investment but are also equipped to manage your franchise’s ongoing financial commitments effectively.
Can You Negotiate Franchise Fees?
Franchising is rooted in the principle of consistency; this extends to the fee structure as well. If you’re a novice franchisee, chances are the franchise fee is usually non-negotiable.
This is because franchising contracts, typically termed as contracts of adhesion by legal professionals, are designed to be standard, with little room for alteration.
That being said, if you’re a seasoned franchisee with an established relationship with the franchisor, there might be some wiggle room. Still, for most entering the franchise arena, negotiating fees remains a distant possibility.
The Negotiation Process for Franchise Agreements
Entering a franchise agreement is a significant commitment that necessitates careful negotiation to ensure the terms align with your business goals and financial capabilities. While franchisors typically present a standard contract, certain aspects may be negotiable, especially for well-prepared and informed candidates. Here’s how to navigate the negotiation process:
- Understand Your Leverage: Your negotiation power can be influenced by various factors, including your experience, financial resources, and the franchisor’s desire to expand in your target market. Assess your strengths and how they align with the franchisor’s goals to identify potential negotiation points.
- Prioritize Your Negotiation Points: Not all aspects of the franchise agreement will be negotiable. Identify the terms most critical to your business success, such as territory rights, initial fees, or royalty structures. Focusing on a few key areas increases your chances of successful negotiation.
- Seek Legal and Financial Advice: Before entering negotiations, consult with a lawyer experienced in franchise law and a financial advisor. They can help identify potential issues in the franchise agreement and advise on realistic negotiation goals.
- Prepare Your Proposal: When you approach the franchisor with negotiation points, present a well-reasoned proposal that outlines your requests and their justification. Demonstrating how your suggested changes benefit both parties can make your case more persuasive.
- Be Willing to Compromise: Negotiation is a two-way process that may require compromise from both parties. Be prepared to prioritize your requests and understand which points you’re willing to concede in exchange for concessions on more critical issues.
- Understand the Franchisor’s Perspective: Recognize that franchisors need to maintain consistency across their franchise network. Understanding their perspective on certain non-negotiable elements, such as brand standards and training requirements, can facilitate more productive negotiations.
- Document Everything: Ensure that any agreed-upon changes are reflected in the final franchise agreement. Review the revised contract carefully, preferably with your legal advisor, before signing to confirm that all modifications are accurately documented.
By approaching the negotiation process with preparation, clarity, and a willingness to engage in open dialogue, prospective franchisees can work towards an agreement that supports their business objectives while maintaining the integrity of the franchise system.
Do Fees Vary?
As you delve deeper into franchising, you’ll realize that a one-size-fits-all fee doesn’t exist. Each franchisor establishes its fee structure, tailored to its business model and market presence.
Sometimes, these fees are structured based on dynamic variables. For instance, the fee might be contingent on the number of consumers in a designated territory.
As a prospective franchisee, it’s crucial to meticulously analyze each franchise’s fee structure to make an informed decision.
There are other situations where fees may vary, including for:
- multi-unit development;
- master franchises;
- renewal fees charged when the franchisee renews the agreement– these may be lower or subject to negotiation; or
- applicants who are veterans, minorities or the first X number to apply when it’s a new franchise.
What if You Don’t Pay?
Choosing to forgo or delay the payment of franchise fees isn’t a decision to be taken lightly. A franchisee’s commitment to meeting financial obligations as stipulated in the franchise agreement is paramount.
Defaulting on payments can lead to severe ramifications, including the potential loss of the franchise license itself. Beyond that, the franchisor might initiate legal proceedings against the defaulting franchisee, further compounding their challenges.
Withholding as a Protest
There might be scenarios where a franchisee feels short-changed – perhaps they believe the franchisor isn’t providing the promised support or resources. In such cases, the idea of withholding royalty fees as a sign of dissent or to exert pressure on the franchisor can seem tempting.
However, acting on such impulses can be detrimental. Legal experts, such as the team at Garner, Ginsburg and Johansen, P.A., caution against such a course of action.
They emphasize that retaining royalties or other dues might inadvertently provide the franchisor with even more leverage over the franchisee, putting the latter in a more vulnerable position.
Seek Legal Counsel
It’s imperative that franchisees understand the gravity of their financial commitments and the consequences of defaulting. If disagreements or concerns arise, rather than resorting to withholding payments, it’s wiser to seek legal counsel.
A seasoned attorney can offer insights on the best course of action and help navigate the complexities of the franchise agreement. With their guidance, franchisees can address concerns and disputes more constructively, minimizing risks and ensuring smoother operations.
In a Nutshell
Franchising involves a symbiotic relationship between the franchisor and franchisee, bound by contractual obligations. Franchise fees – be it one-time payments or recurring royalties – are central to this relationship.
While most of these fees are non-negotiable, they reflect the franchisee’s commitment to the business. In the face of disagreements or perceived lapses, open communication and legal counsel are far more effective than withholding payments.
It ensures the franchisee’s rights are protected while maintaining the sanctity of the franchise relationship.
