If you’ve decided that it’s time to franchise, you’ll probably find yourself hunting for information on how to structure your franchise system. One of the most important components—at least for franchisors—is how much to charge franchisees for the right to use the brand name and the franchisor’s system.
Untangling all of the jargon and key terms that pop up repeatedly throughout the franchising process is the first step in understanding what it takes to franchise your business from a legal perspective. Armed with this essential knowledge, you’ll be better prepared to move forward on the path to expanding your brand. Today, we’re diving into the idea of franchise fees. Here’s what you need to know about them before you begin the franchising process.
What Is a Franchise Fee, and Who Pays It?
As a franchisor, you’ll be fronting a number of startup costs for everything from acquiring experienced legal counsel to creating a standardized operating handbook to be used at each of your franchised locations. Fortunately, the franchise fee is not another thing you’ll have to finance; it’s a fee paid to you!
Initial Franchise Fee
Think of the initial franchise fee as an upfront “cost of entry,” or the price a potential franchisee pays in order to own and operate a franchised location of your company. This isn’t the part where you start making a profit, however. Your franchisee will pay this one-time fee to you to cover pre-opening costs such as training and location and buildout approval.
Royalties and Marketing Fees
Once a franchised location is up and running, your franchisee will begin to pay you ongoing or other fees, which typically include royalties and marketing or advertising fees paid weekly or monthly. These additional fees are usually based on a percentage of the revenue generated by that franchised location, but they may also be weekly or monthly flat fees.
Royalties usually cover the costs of any resources you provide to your franchisee on an ongoing basis, such as updates to that operating handbook as needed. Franchisors should set their royalties at an amount that will generate them a reasonable profit.
Marketing fees are paid in return for the work you put in managing and advertising the brand. These fees are usually paid to a separate bank account administered by you (i.e., a brand fund), and you’ll then use them to place local, regional, or national advertising and to conduct marketing campaigns. It’s important that you put these marketing fees to good use, as a strong brand will attract more potential franchisees.
Many franchisors also charge other periodic fees, including software licensing fees, website or technology fees, equipment leasing fees, and additional training fees.
Oftentimes, a franchisor will use a specific vendor (such as a software provider) for a certain good, product, or service provided to franchisees, and in these cases, the franchisor passes on the costs for this vendor to the franchisee. For example, in a hotel franchise, the franchisor may use a proprietary reservation system from a third party software vendor. The hotel franchisor would charge franchisees a periodic fee to use the reservation system.
Payment of Fees
Franchisors can collect franchise fees in several different ways. While initial franchise fees are often lump-sum payments due upon signing a Franchise Agreement, some franchisors will allow a franchisee to “finance” the initial franchise fee and pay it in installments.
Royalties, marketing fees, and other periodic fees are usually charged weekly or monthly. More and more franchisors are moving to weekly payments, however, for several reasons:
- First, weekly payments would normally be a quarter of the amount of a monthly payment, making them more palatable to prospective franchisees.
- Second, weekly fees allow the franchisor to stay ahead of potential non-payment defaults, as the franchisor will know if a franchisee may have trouble paying a periodic fee up to 3 weeks earlier. This gives the franchisor the opportunity to get ahead of the problem and present a solution to the franchisee.
Nearly all franchisors today take fees via electronic funds transfers from the franchisee’s bank account to the franchisor’s bank account. The franchisor should be preauthorized to debit the franchisee’s designated bank account for these fees without having to request or wait for the franchisee to pay each week or month (assuming the franchisor can calculate any fees based on a percentage of revenues). Ultimately, the franchisor should have independent access to the financial records, including sales receipts, of the franchisee so that it can calculate these fees on its own!
A well-drafted Franchise Agreement will allow the franchisor to enforce its rights, including payment and collection of its fees. If a franchisee fails to pay a fee on time, the franchisor may exercise its rights under the Franchise Agreement by sending a default notice to the franchisee. If the franchisee fails to cure the default within a certain period of time, the franchisor may have grounds to terminate the Franchise Agreement, depending on state law.
Get Your Franchise Up and Running with Larkin Hoffman
Expanding your company from one or a few locations to a franchised business is a journey—and we want to be there every step of the way. At Larkin Hoffman, we use our decades of legal experience to help clients big and small remain compliant with franchise laws and regulations while structuring a franchise system that works. Reach out today to schedule a complimentary initial franchise consultation, or take our Fit to Franchise evaluation for some additional insight into the franchise potential of your company.