What Is a Franchise Fee – Franchising 101

The business cannot be started without investment, and the franchise, in this regard, is no exception. Paying franchise fees is treated as mandatory – as investments without any franchise cooperation cannot be imagined! The franchise fee payment is what will give the franchisee the right to use franchisor trademarks, products, and intellectual property.

How much money needs to be invested in starting a business under the auspices of a well-known brand largely depends on the fees and the sector in which the franchisee operates. The requirements of the system whose franchise the recipient buys must be respected.

It is clear that when you are opening a restaurant – especially if it is a famous fast-food giant – the franchisee will have to invest incomparably more money and pay a more franchise fee than an entrepreneur who decides to open a jewelry store or foreign language school.

However, no business can be started without any investment. When it comes to buying a franchise, it is important to know that, in addition to investing in administration, renting, arranging, office equipment, and current liabilities, there are mandatory investments, which are an integral part of the franchise relationship between franchisor and franchisee.

What Is a Franchise Fee

The franchise fee is a payment that every franchisee must pay. This payment gives you the right to use franchisor trademarks, products, and intellectual property. The fees that must be paid are an initial fee, royalty fee, and marketing fee. These are expenses that every future franchisee owner will have.

Commonly, the franchise fee term often comes around when people are investigating which franchise to start. To have complete knowledge about a franchise fee, we will go through all the details that will be helpful for future investors.

The fee rates are different for every franchise, and the buyer must pay these fees if he wants to be part of a particular franchise. Some fees are paid only once as the initial franchise fee; other fees must be paid monthly (royalty and marketing fee). If you don’t pay only one of these three fees, the franchise contract can be nullified.

It is important to get consult with a lawyer before signing any kind of franchise agreement.

Most of the time, people interested in buying a franchise have many questions about franchisee fees, and they want to know if the franchising business is profitable. You as an investor must be aware that by paying all these fees, you will get turnkey business, and your brand will be globally/ nationally well-known, so you will don’t need to invest a lot of money in marketing and other things that are correlated with it.

Basically, a franchise fee is a cost that is required to be paid if you want to be a registered member of a particular franchise. Franchisor as a McDonalds, Subway, KFC or any other wants to franchisors be only people who have liquid assets and good managerial skills. It is not easy to become part of a well-known franchise because requirements are rigorous, and franchise fees are very high.

How do Franchise Fees Work

Franchise fees work as a glue that binds two parties involved in this business model. The franchisor and franchisee work in symbiosis, and one can’t be successful without the other. The goal of every franchisor is that their franchise has higher gross revenue because, in that way, it will pay more of the royalty fee, and the franchisor’s profit will be higher.

When they found out what is the franchise fee, some investors become skeptical about this business model. They start to wonder is it better to start a business from scratch or it is better to invest in buying franchises. The initial franchise fee for some of the better brands, such as McDonald can be more than $ 500,000, but there are also cheaper options available in the market.

Before defining if it is worth paying franchise fees, it is important to look over the meaning and objective of a franchise. Usually, a franchise is set up a long time after the establishment of the main company. Also, by paying these fees, you have better possibilities and a wider base of customers than you will have if you start a new business without a name on the market.

Franchisors have developed business strategies, and by paying franchises fee, you will get an established business that can be very profitable. Also, you will get help with education, equipment, marketing, and suppliers.

In return for franchisor help, the franchisee will pay a royalty fee that can range from 4% of gross revenue all the way up to 12% or more.

Therefore paying to join a franchise can be profitable for the part of both parties. You will get an established business with a wide base of loyal customers, and the franchisor will get a percent of your monthly gross revenue.

Sometimes the franchise fee seems to be too much. After getting complete knowledge of what is a franchise fee and what advantages it offers, you will be able to decide if the franchise business model is right for you. At least it is better to pay for the franchise and avoid the risk of failure than to risk your money in starting a new business altogether.

Types of Franchise Fees

Usually, there are 3 types of franchise fees that every investor in starting a franchise will encounter.

Types of the franchise fee:

  • Initial franchise fee
  • Royalty franchise fee
  • Marketing franchise fee

What is the initial franchise fee?

In order to become part of the franchise system at all, the franchisee must pay for a license – the so-called initial franchise fee. This is a one-time amount for which the recipient receives the right to operate under the desired brand and within the desired system. By paying it, investors gain access and privilege to apply the franchisor’s know-how (all specific business knowledge and experience).

Since sometimes these are large amounts of money, it is quite expected that franchisees will wonder how much such an investment is worth. If it is a franchise with a recognizable and strong brand, the calculation is favorable. In this case, the recipient is more likely to attract more customers and clients from the first moment of business than if the business is started under a new and unknown brand.

The greatest recipient benefit from paying the initial fee is the availability of training, that is, the transfer of proven protocols and business processes – this is considered as one of the main advantages of franchise cooperation. By accepting these guidelines, practices, and knowledge, the recipient “saves” time and money on the mistakes that would be made if investors start their own business from scratch.

The franchisor has already faced the most common business problems and already knows how to completely avoid or solve them, except that the franchise system gives insight into all business procedures and protocols. The recipient also receives guidelines in the form of an operational manual, which contains the best business practices, with detailed explanations of what and how to do it.

In addition, it should be noted that the entrance fee very often covers the assistance of the franchisor in choosing the location and arrangement of the office and assistance in hiring staff and procurement of basic materials and equipment. This will be a lot of help for people who are starting their own business for the first time.

The cost of the entry fee varies from system to system – it can range from a few thousand to several hundred thousand dollars. More expensive franchise fees are generally tied to extremely strong, world-renowned fast-food chains that have tens of thousands of restaurants worldwide, and franchisees, in this case, are most often large and reliable companies globally known.

What is the franchise Royalty fee?

Another type of fee that the recipient must pay regularly is the royalty fee. It is usually determined as a percentage of gross revenue, but it can also be in the form of a fixed amount of money or, in rare cases, as a margin on goods that the recipient receives from the franchisor.

The royalty fee must be paid for the whole duration of the franchise agreement and, depending on the contractual terms, can be paid on a monthly, quarterly, or annual basis. In essence, this fee represents a main source of revenue for the franchisor.

On the other hand, the franchisee has a reason why to pay this fee because by paying this so-called “membership fee,” the owner can count on the constant support and assistance from the provider. The franchisor will constantly improve the system, monitor and train recipients and employees; also, it will negotiate better terms of procurement of goods and equipment from suppliers (this will benefit both parties).

What is the franchise marketing fee?

When you become a part of the franchise system, you will be obligated to pay a marketing fee in most cases. The revenue usually determines how much it will cost, and it is paid on a monthly basis. As practice has shown, whether it is large, developed franchise systems with a global presence or businesses that are fighting for their place under the sun, investing in marketing is essential if you want to build a profitable and sustainable business.

Therefore, if a provider has mandatory marketing fees, the benefits of this investment should be felt by all its franchisees. The provider mainly invests in brand promotion nationally or globally, while the franchisee is expected to invest in marketing locally.

Usually, marketing fees range from 1 to 6% of the franchise gross revenue, and it is paid on a monthly basis.

Are there more fees than this three?

It is very rare for a franchisor to ask for more fees than we have mentioned. It is much more common that certain fees are paid indirectly (through the margin on the goods that the recipient procures from the franchisor). Sometimes, the provider, in order to franchise brand penetrate into a particular/new market, offers help by reducing the initial(entry) fee; this is also a common practice when the franchisee decides to open more than one branch at the same time.

If you want to determine if these franchise fees leave you enough room for profit, the easiest way to find the answer to this question is to network with the people who started that particular franchise before you. In this way, you will get an insight into things that the franchisor often does not mention in the contract.

The responsible franchisor knows that the fees should be neither too high nor too low. In the long run, the imbalance in fees can harm the franchise system – too high fees discourage the recipient and too low the franchisor. Also, as we have mentioned several times, consult a trustworthy lawyer who has experience with the franchise business system before signing a franchise disclosure document.

How are Determined Rates of Franchise Fees

Many factors impact how much the initial and other franchise fees will be charged by a franchisor. Most companies in the same niche of the business will tend to have a relatively similar fee. In most cases, competition determines the fees that a franchise company will charge to its clients.

If you don’t have big start-up capital, then it’s best to choose to buy a franchise that is just breaking into the market. This way, you can take advantage of the benefits of this business system without having to invest hundreds of thousands of dollars.

In most cases, when determining the amount of compensation, the franchisor has already made projections of the expected income of its franchisees, and it ensures that the level of compensation is equally acceptable for both parties in this business partnership. Therefore, it is necessary that the provider carefully consider and assess the economics of the relationship when determining the entry and regular fees.

When you, as a franchisee, pay all these fees, your franchisor will be able to finance all its daily business activities.  The amount of fee you will pay also depends on how popular some brand is. If there are more possible investors in some franchises, it is normal that the initial franchise fee will be higher.McDonald’s, Subway, and other popular franchises have a lot of interested investors, so the cost of starting this kind of franchise is very high.

Franchise fees will also fluctuate depending on what kind of franchise system you choose. Different franchise businesses will have different rates of fees. The uniqueness of the system will determine if the rate is high or small. If you have a sophisticated system, then the fees are likely to be high. This is because this system will offer high-quality services, and you will start a turnkey business that can make a profit immediately.

The profitability of the franchise also has an impact on the rate of fees. If you buy a franchise that will be giving out good returns in terms of profit, then the fees charged will be high. The more profitable the business is, the higher is the rate of the fees. This is the main reason why franchisors will give good foundations to its franchisee because in that way they will be profitable enough to pay high fees.

The expenses of the company are another factor that has affected the franchise fees rates. If the cost and expenses used to run a business are high, then the fees are likely to be high. This is because the money paid in terms of fees is the one used to service the company’s daily expenses. This is the money that will be used for marketing and for training.

The franchisor spends money from the fees on advertising, organizing seminars, and training new franchisees. All these are expenses that will be covered from the amount of money gotten from fees. If these expenses go high, then the fees rate will also shoot higher.

Summary

It is very easy to understand what is a franchise fee; as you can see for yourself, this business model is based on the symbiosis between franchisor and franchisee. Sometimes these fees are very high, but you must be aware that every business needs investment in order to be able to compete in a market that is almost oversaturated. Also, by starting a franchise, you have a better chance to succeed.

When we compare how many startups fail and how many franchises fail, we see that franchise is a more secure investment than starting a business from scratch. Yes, you will need to pay some fees, but it is worth it if you choose a franchise that knows what it’s doing and that is already well established on the market.

Franchising is a great way to get into entrepreneurship because it can protect you from beginner mistakes, but this business model does not necessarily guarantee success. Business success requires quality business planning, hard work, and a little luck.

Franchising allows you to start your own business more safely, and by paying these fees, you will get help and guidance on how to run a successful business.

 

Written by:

Stuart MacPherson

Hi, I'm Stuart. I've been running my own small business since 2019 after leaving a successful career in finance. I created FranchiseTheory to share my enthusiasm for franchising and the franchise business model.

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