How franchise royalty payments really work

03/07/2018 08:00 | Start a business

How the franchise royalty fee works

Many aspiring business owners considering becoming a franchisee are often confused by the cost of a franchise. Most tend to just think about the franchise fee without understanding the other costs involved. This is understandable as the franchise fee is the upfront payment that is made to the franchisor which can range anywhere from a thousand pound to a few hundred thousand pounds.

But while the franchise fee reimburses the franchisor for the cost of recruitment, training, and the right for you to use the brand name, trademark, and logo, there are many other elements of the franchise which require ongoing payments. One such payment is known as a royalty payment and generally covers the costs associated with keeping the brand growing and thriving.

Why do I have to pay the royalty fee?

Your reasons for wanting to invest in a franchise probably include a desire to run a sustainable and profitable business. And although your ability to make money is essential, the longevity of a franchise depends very much on the franchisor's capacity for making a profit too.

Because the franchisor doesn't tend to make any money from the initial payment that you and other franchisees make, the royalty fees are a chance for them to generate an income. Of course, the franchisor doesn't pocket the full amount. Most of the money is reinvested back into the business so that franchisees can continue to be supported and the franchise can be developed and expanded.

The ongoing support and training that the franchisor provides are funded through the royalty payments, as is the administrative costs of running and maintaining the franchise system. For this reason, you want to make sure that the cost of a franchise royalty payment is proportionate to the amount of support you receive. The franchise agreement will provide a breakdown of the fees youll be expected to pay, as well as detailing the ongoing training and support youll receive in return.

How much is the royalty fee?

There are several ways the franchisor can determine how much to charge for the ongoing royalty fee. The most common way is calculated as a percentage of your gross sales. No set amount is charged, but generally the rate ranges from between 5% and 9%. The fee is regularly paid to the franchisor, with monthly being the most probable frequency.

In most franchises, this percentage is fixed, but some franchisors choose to increase or decrease the rate depending on the level of sales. With a variable percentage, its likely that the franchisor will require a minimum royalty fee per month to ensure that that the payment can cover necessary expenses.

You may also come across franchises that charge a set royalty fee, regardless of how well the franchise is performing, and there are even some that dont require an ongoing royalty payment at all.

How do I know that the royalty fee is fair?

Good franchisors will put time and effort into making sure that the royalty fee that they charge is attributable to the support thats being offered. After all, its in the franchisors best interests that youre successful, so they should do their best to set the royalty amount at a level that will enable you to make a healthy profit. The franchisor should be prepared to study elements of your franchise, such as employee expenses, stock costs, and rent so that they can fully understand what percentage to set the royalty payment at.

This is one of the reasons why it is so important to consult a solicitor that specialises in franchising to review the franchise agreement with you. They will be able to advise you whether the royalty fee is fair based on your industry, as well as the size and location of your franchise. Unfortunately, too many franchisors apply whatever percentage their competitors are charging, or worse, make a number up with little to no basis for it. An expert legal advisor will be able to help you understand exactly what youre signing up to.

Are there any other ongoing fees that Ill have to pay?

As well as the initial fee and the royalty payments, the cost of a franchise can also include:

Marketing or advertising fee

This fee is a contribution to a centralised marketing fund which is used to promote the franchise and brand at a national level. As with royalties, the fee structure can differ from franchise to franchise, but the marketing fee tends to be calculated as a percentage of your gross sales. While these payments fund national advertising campaigns, it's still crucial that you invest in local marketing activity to raise awareness of your franchise within your community.

Renewal fee

The franchisor may apply a renewal fee if you wish to renew your franchise agreement after the initial term comes to an end. Renewal of the contract isnt automatic as the franchisor must agree to it.

The franchisors agreement to renew will depend on whether you've met specific criteria which you can find detailed in your franchise contract. If you have reached the stated criteria and you decide to renew, you may have to cover the cost of additional expenses as well as the renewal fee. For example, one of the conditions of the renewal may be that you must refurbish your business premises to ensure that the brand's high standards are maintained.

On the other hand, some franchises dont charge a renewal fee at all. Before you sign on the dotted line be sure to have a full understanding of the costs involved in purchasing a franchise. Not just at the beginning of your franchising journey but through to renewal, and eventually, exit.

Transfer fee

You may also be charged a fee if you choose to sell the business at any stage. As the franchisor will want to ensure that the franchise is sold to the right franchisee, its not quite as straightforward as just finding a buyer. The franchisor will need to approve any prospective buyer before the sale goes through, following the same robust recruitment process that you will have had to go through. The transfer fee reflects the fact that the franchisor will have to provide training and other services to the buyer.

The franchisor may be better placed to find a buyer than you, in fact. This is because they may have been approached by potential investors interested in your territory in the past. If the franchisor does find an interested party, who then ends up buying the franchise, theyre also within their rights to charge you for making the introduction.

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