What is an Initial Franchise Fee?

An initial franchise fee refers to the amount of money you pay to the franchisor when you sign your franchise agreement. Fees vary by organization and typically reflect the size and scope of the franchise you're buying. The payment of a flat, one-time initial franchise fee defines your business as a franchise of the parent organization and makes you a member of that franchise's business family.

Requiring a franchise fee is one of three elements your new business must meet to qualify as a franchise. The FTC identifies your business as a franchise if your arrangement with the franchisor meets the following criteria:

  1. As the franchisee, you're granted the right to operate a business and provide goods or services associated with the franchisor's trademark and other proprietary systems.
  2. The franchisor promises to exert a significant degree of control over the way your business operates or provide significant assistance in the way you operate your business.
  3. You're required to make a payment to the franchisor or commit to making a required payment of at least $500 during the first six months of operation.

In most organizations, the initial franchise fee covers more than the cost of admission. Typically, this payment includes the cost of your application and entitles you to use your franchise's branding and business plan. It can also cover costs related to startup training, marketing, advertising, and any other support you receive from the corporate team to establish your new business.

What are Ongoing Franchise Fees?

The type and number of ongoing franchise fees vary for each organization. You pay ongoing franchise fees on a regular basis as long as you remain part of the franchise system. The most common types of ongoing franchise fees include:

Royalty fees

Franchisors typically calculate a royalty fee as a percentage of your gross revenue. Industry averages range between 4% and 9% of gross sales, but franchisors can establish it at any percentage in the franchise agreement.

Some franchise royalty fees aren't variable. Instead, they're set as a fixed amount that you owe no matter how much money you make. Depending on your franchise agreement, you may have to submit this payment on a regular schedule that can be weekly, monthly, or at another predetermined interval.

Regardless of how they're calculated, royalty fees represent the primary source of profits for franchisors. Royalty fees also finance your franchisor's efforts to expand and recruit new franchisees. Depending on the terms of your franchise agreement, your royalty fees may also entitle you to receive:

  • Ongoing education and training
  • Revisions to operating manuals
  • Upgrades to franchise-specific software
  • Business consulting
  • Administrative support

Advertising fees

Another type of ongoing franchise fees includes advertising and/or marketing fees. Like royalty fees, advertising fees are paid on a regular basis and may be set as a constant amount or an amount that corresponds to your gross sales, though typically at a lower percentage than royalty fees.

Most franchisors combine all advertising fees into one fund that finances national and/or regional promotions for the entire franchise system. When franchisors administer their own advertising funds, they may reimburse themselves for the cost of doing so.

How Do Franchise Fees Affect My Profits?

You can find out how your franchisor's fees affect profits by talking to an existing franchisee in the same organization. Ask the franchisee about their typical monthly revenues and their ability to pay the required fees. Find out whether they're still making a reasonable profit after meeting their obligations to the franchisor. Based on their feedback, consider whether earning this rate of return on your investment is what you're willing to accept as a new franchise owner.

An existing franchisee can also tell you whether the franchise advertising fees deliver a fair return on their investment. One of the advantages of purchasing a franchise is to benefit from being associated with a proven brand. Ask current franchisees whether they think their advertising fees are used to promote the franchise adequately and consider their responses in your financial planning process.

Can I Negotiate My Franchise Fees?

Franchisors typically don't negotiate franchise fees for several reasons. Primarily, the FTC's franchise criteria require that any material change or consideration given to one new franchisee must also be offered to other prospective franchisees. So, if the franchise offers you a discount, the company must provide the same discount to everyone else considering a franchise purchase.

Changing established terms means pausing negotiations with all interested buyers to allow the franchisor to amend and correct the UFOC to reflect the discounted rate. It's a complication that most franchisors won't consider.

When every franchise operates on the same scale, it's easier for the franchisor to collect and manage fees. Uniform franchise fees prevent the corporate staff from having to handle each franchise differently.

Offering financial discounts to new franchisees can also disrupt the community of consistency that contributes to franchise success. Having an equal playing field can make franchisees more willing to support each other for mutual gains across the franchise organization.

What Happens If I Can't Pay My Ongoing Franchise Fees?

When you sign your franchise agreement and pay the initial franchise fee, you're legally bound by the terms of the agreement to pay your ongoing fees according to the amount and schedule specified. Missing payment of an ongoing franchise fee may put you in breach of your franchise agreement and make you subject to legal consequences.

Depending on the conditions outlined in your franchise agreement, your franchisor may have the right to terminate your franchise when you miss payments. Holding back franchise fees for any reason, even if you believe the franchisor isn't fulfilling their obligations, can result in termination of the franchise relationship and additional financial loss.

If you're unable to pay ongoing royalty or advertising fees because of low revenues, you may benefit from legal advice to understand how this can affect your business. Ultimately, your best option may be to contact the franchisor and explain your situation. If your financial problems are temporary, your franchisor may be willing to work with you so you can rebound before resuming these payments, though the franchisor isn't obligated to do so.

You'll receive the details regarding your organization's franchise fees before you sign your franchise agreement. Make sure you understand the dollar values of these fees and the formulas used to calculate them. Ignoring your obligations for franchise fees can damage your relationship with your franchisor and ultimately jeopardize your franchise ownership.

"Franchise Fees" is a part of our complete guide on How To Buy A Franchise.

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