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. Here’s the breakdown of the three most common types of franchise fees:
- an initial franchise fee;
- ongoing royalties – fees paid monthly or at other regular intervals; and
- a periodic advertising and marketing fee.
Some franchisors charge additional fees including technology fees, audit fees, insurance, and training fees. Each franchisor sets its own fee structure.
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 Federal Trade Commission’s Franchise Rule imposes a strict requirement to disclose all fees, in something called the Franchise Disclosure Document or FDD. The franchise company is required to give each prospective franchisee a copy of the FDD, and have him or her sign for it.
Some franchisors may also provide a bit of information on their websites or in brochures about fees, costs and requirements in general. However, such information does not replace the required FDD disclosures.
Franchise Fee vs Initial Investment – the Same?
The initial investment is broader than the franchise fee, and gives a more detailed look at the entire investment a prospective franchisee would need to make.
According to the FTC Franchise Rule, franchisors must lay out in an itemized tabular format the entire estimated initial investment. This number includes all the expenses a franchisee needed to start the business. This includes the opening inventory, rent, security deposit, signage, initial training and other costs.
Can You Negotiate Franchise Fees?
For first-time prospective franchisees, the answer is usually no. The franchise system is based on uniformity for all. You must fit into the franchise system — not the other way around.
The typical franchise agreement is a boilerplate contract. Lawyers refer to them as contracts of adhesion. This means that terms are standard and not typically negotiated. If you are an existing experienced franchisee it may be different — you might be able to negotiate a special franchise fee. But don’t expect negotiations for your first foray into franchise ownership.
Do Fees Vary?
There is no such thing as a “standard” franchising fee that all franchisors adopt. Each company sets its own fees.
Sometimes you will see fees expressed in a variable formula, such as X dollars per number of consumers in a territory.
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?
Nonpayment of franchise fees has serious consequences. You could lose your franchise business or be subject to other legal action.
Sometimes franchisees become unhappy, feeling they are not getting sufficient support and assistance. As a franchisee, you may want to withhold royalty fees to express displeasure or try to force changes.
According to the law firm of Garner, Ginsburg and Johansen, P.A., withholding payment is usually not the best option. The lawyers write on their website: “We almost always advise franchisees to continue paying royalties to avoid giving the franchisor significant leverage.”
Make sure to consult with your own lawyer for help.
Summary
Franchise fees are any amounts the franchisee must pay to the franchisor in order to operate a franchise. These are usually a combination of once-only and ongoing payments. Most franchise fees are not negotiable.
This article, “What is a Franchise Fee and How Much Will I Owe?” was first published on Small Business Trends