Understanding Franchise Royalty Fees

 

There will also certainly be ongoing costs, both the direct costs of the goods and services sold and the overhead for the business. But franchise businesses also usually involve ongoing payments to the franchisor, known as royalty fees.

 

The upfront price that goes to the franchisor is not really the price of the franchise. Those funds are expected to cover the franchisor’s costs for helping to launch the new franchise. These costs may include any or all of the following:

 

• Training for owners and key employees
• Training materials
• Software for managing the business
• Forms and operational manuals
• Marketing materials
• Consultation or on-site visits
• Equipment needed
• Starting inventory
• Supplies required to provide services
• Administrative costs
• Legal costs

 

This is not an exhaustive list; a franchisor may provide a complete “business in a box” with everything from signage to uniforms, for example, or may provide initial leads and contracts with local clients. This varies enormously from one franchise to another.

 

Theoretically, when the franchise opens, the franchisee will have paid for all the things that the franchisor puts into the deal. However, the continued use of the franchisor’s name and registered trademarks, not to mention the system or other trade secrets, also has a price. That’s not usually covered by the initial fees.

 

 

Instead, the franchisee pays royalties to the franchisor. These ongoing payments can be a regular flat fee. This has the advantage of being predictable. You can budget for a flat fee, and you can feel sure that you will keep additional profits you earn through your hard work. Franchise fees can also be based on purchases, if the franchisor supplies materials to franchisees.

 

However, it is more common for a franchisor to require a certain percentage of sales revenue from the franchisee. There are some complications with this system. For example, the franchisor has to trust that the franchisee is keeping accurate records of sales. The franchisee, by the same token, has to keep accurate records. If there is a dispute between the franchisor and the franchisee over the amount of revenue earned, the franchisee will usually have to provide sales records. If the franchisor provides a point of sale system, the figures in that system may take precedence over reported revenues.

 

Since the royalties are typically calculated on the basis of revenue rather than profits, some franchisees also feel that the franchise system is focused on sales rather than profits, making it harder for franchisees to do well. Headline-grabbing disputes about low-cost promotions such as “Dollar Menus” usually stem from this issue: franchisees worry that franchisors push marketing or systems that keep sales high but may also keep profits low.

 

However, franchisors know that their income depends on their franchisees’ success. Just make sure that you fully understand the royalty requirements for the franchise you are considering before you sign up.