Royalty Fees Benefit the Franchisor and Franchisee
Franchise fees give you the right to own and operate a business. The initial franchise fee is a cost the franchisee has to pay for the franchisor's proprietary business systems and the license needed to operate the business. It is sometimes referred to as an “initial fee.”
What many people don’t know is that franchisors typically don’t make money from the one-time franchise fee. The franchise fee is used to cover a franchisor’s costs including the support team’s salaries. Franchisors profit from royalty fees.
The idea behind a royalty fee is that when the franchisee makes money, so does the franchisor. When you pay a royalty fee, it is usually collected by the franchisor on a monthly basis and is calculated based on a percentage of the franchise’s revenue. Typical franchise royalties range from 4% of your revenue to 12% or more based on the type of franchise business.
For example, a food franchise is a high-volume business where many customers buy individual items. Thus, it’s not uncommon for the franchise to exceed $1 million in annual revenue. Due to the business’ volume, the franchise royalty percentages are usually on the lower end. If it makes $1.5 million annually and has a 5% royalty fee, for example, $75,000 would be due in royalties.
On the other hand, if you own a business that makes less in revenue than a typical food franchise, the royalty fee can be as high as 10%. This fee, along with other ongoing fees for insurance, technology, and more, are listed in item 6 of the Franchise Disclosure Document (FDD), which you must read before investing in a franchise. The FDD also contains your franchise agreement.
If you need help paying for these fees, there are financing options that you can look into, like the U.S. Small Business Association (SBA), to help you achieve your business goals. Some franchises even offer in-house financing options.
Additional Fees Associated with Owning a Franchise
According to the SBA, franchise fees range from anywhere between $20,000-$50,000. The price is higher for master franchises, which involve purchasing and selling franchises in a large geographical area. A master franchise’s franchise fee can run upwards of $100,000.
It is essential not to confuse a franchise fee with the business’ total upfront cost. For example, a franchise fee may be $40,000, but the all-in investment is likely well over $100,00 or even into the millions, depending on the brand and what’s needed to get the business up and running. Part of the due diligence process is understanding the upfront costs required to open the franchise.
Franchise Marketing Fees
One of the many benefits of owning a franchise is brand recognition. The franchisee wants to capitalize on the brand's popularity. Increasing brand awareness involves advertising and marketing, for which the franchisee pays a marketing fee. Some franchisors don’t charge this fee, but many do. Fee structures vary from brand to brand, so it’s something to be aware of.
Franchisors can spend tens of thousands of dollars every year for the brand’s advertising. They base the marketing fee on the franchise’s monthly earnings. For example, if a business's average monthly revenue is $25,000 with a 2% marketing fee, the franchisor is owed $500, or $6,000 annually.
Franchise Due Diligence
Before investing in a franchise business, it is vital to do your due diligence and speak with franchisees in the field. Speaking with franchisees who have experience owning and operating a business is a great way to determine whether or not a brand is right for you. Before speaking with franchisees, prepare a list of questions. Here are some examples:
- Is running this business what you expected?
- What are some problems you’ve encountered, and how did you overcome them?
- Is the investment in a franchise worth it?
- How long did it take you to see a return on your investment?
- What are some of the positive aspects of running this business?
Speaking with a Franchise Consultant
As an entrepreneur who wants to open a franchise, you should meet with a franchise consultant. This professional who will look at your finances, skills, and experience to help you determine if franchising is realistic for you. The consultant will also go through the FDD with you and look at the fees to see if they are within industry standards.
Since the consultant gets a commission when a franchise business is awarded to a prospective candidate, you won’t have to pay the consultant anything for their advice. On top of understanding how to own a franchise that they work with, they can explain the franchise cost and help you better comprehend the FDD and the franchise agreement.
Another important aspect of due diligence before owning a business is attending discovery day. During this event, you can ask questions to the franchisor and members of the leadership team. These questions can include:
- How are franchise owners supported?
- How long does it typically take to open a franchise store?
- How would you say the franchisor v. franchisee relationship is in the system?
- Have you ever fired a franchise owner? If so, why?
After the event is over, it is best to sleep on it and seriously think about if owning a franchise is right for you. If you still believe that the franchise business is a good investment after the franchisee validation process, then go all-in.