The Initial Franchise Fee is a One-Time Payment for the Right to Own and Operate the Franchise
When contemplating whether or not to invest in a franchise, you likely have questions about the fees you’ll have to pay and what they cover. As a prospective franchise owner, you cover all costs that the franchisor outlines in the Franchise Disclosure Document (FDD). In franchising, there are two types of fees: an initial franchise fee and ongoing franchise fees.
Initial Franchise Fee
The initial franchise fee is the upfront, one-time payment the franchisee pays the franchisor when a franchise agreement is signed. The franchisee now can use the company’s trademark, operating manuals, proprietary materials, and computer software. This fee is defined in detail in item 5 of the FDD.
Many factors determine franchise fees. These include the complexity of the franchise system, the business’s profitability, and the company’s costs for development and acquisition. What the fees cover can differ from business to business, but some items covered by fees can include:
- Initial training
- Location selection
- Employee recruitment and training assistance
- Pre-opening support
- Marketing tools
- Site build-out assistance
- Supplier access
There are ways to determine if the cost of a franchise fee is justified. For example, weigh a fee’s cost against the expenses of starting a similar independent business, the training involved, and the third-party services used during the process.
When establishing a franchise fee, it is also important to remember that this fee can help a company’s cash flow and initial growth. On the other hand, the royalty fee income and income from sales are important to the company’s long-term profitability. Companies should not focus on making a huge profit from the initial fee, which can deter prospective franchisees from investing in the franchise.
How Much Does the Franchisor Net?
When it comes to the percentage of the initial franchise fee the franchisor nets, it differs depending on the company. Some companies decide to “break-even” on this fee in order to attract candidates. Other franchisors may even decide to lose money on the deal because they know that they’ll make up for it through the ongoing royalty fees the franchisees pay.
It is not uncommon for a franchisor to “net” 25% or more of the total franchise fee, which is also partially a recoup of expenses that they previously incurred. These expenses include franchise development costs, production of advertising and marketing materials, and advertising costs. Thus, revenue generated from the franchise fee is usually higher than the gross profit. Consequently, the gross profit generated from the franchise fee increases as additional franchises are granted and some costs are reimbursed.
What if You Don’t Pay?
There are severe consequences if you don't pay franchise fees. Since these fees are detailed in the FDD, you can be terminated or subject to legal action. A reason why some franchisees may withhold payment is that they are displeased with their franchisor and feel they aren’t being sufficiently supported. Withholding payment can express this displeasure. But legal experts suggest that withholding payment isn’t the best option, as nonpayment would give franchisors significant leverage in litigation.
Franchise Attorneys and Franchise Consultants
When considering if franchising is right for you, speak with a franchise consultant, an expert who looks at your finances, skills, and experience to determine if franchising is right for you. Along with meeting a consultant, consulting with a franchise attorney will help you better understand your franchise agreement and the FDD. These professionals can save franchisees and franchisors alike a lot of legal trouble and headaches.