When you’re evaluating franchisors, you have to wade through a lot of information. You might feel like new terminology is coming at you thick and fast. And then there’s the Franchise Disclosure Document (i.e., the FDD): the legal document that a franchisor must provide for due diligence. Among other important details, the FDD spells out the costs associated with purchasing a franchise. These include franchise fees and royalties–two types of costs that you might assume are similar but are in fact very different. Here’s what you need to know about both.
What Are Franchise Fees?
The phrase franchise fees sounds generic, like it refers to any fees you pay to launch or run a franchise. In reality, it means something very specific: the up-front, one-time licensing fees you pay to the franchisor. Franchise fees give you the right to open a business using the franchisor’s name and brand. They usually also help cover the franchisor’s startup investment in you and your franchise. This investment includes one-time startup assistance, such as initial training, an operating manual, onsite visits, and launch marketing.
Keep in mind that your franchise fee is not the only startup cost associated with purchasing and launching a franchise. Unless you purchase a turnkey franchise (which will be much more expensive than a standard franchise), you’ll have a variety of out-of-pocket costs associated with launching your business. Especially for a brick-and-mortar franchise, these additional costs can actually account for the majority of your startup expense. They might include leasing or buying a storefront and building it out to the franchisor’s specifications, buying specialty equipment and furnishings, purchasing supplies and uniforms, and more. Make sure you account for these costs when you are determining whether you can afford a franchise. The FDD should give you a good estimate of what they’ll be.
What Are Franchise Royalties?
While franchise fees are paid once, up front, royalties are an ongoing cost. Franchisees typically pay royalties on a monthly or quarterly basis. Royalties may be a certain percentage of your franchise’s revenue, or they may be a flat fee per payment period. Some franchisors use a mix of flat fees and percentages. For instance, you might pay a flat fee until your revenue reaches a certain point, then pay a percentage. Or you might pay a percentage on a sliding scale, based on factors such as revenue brackets or how long you’ve been in business. Royalties are meant to defray the cost of the ongoing support you receive from the franchisor. This ongoing support typically includes services such as maintenance and upgrades to proprietary software, ongoing training for you and your employees, and inside sales support.
When you’re evaluating the affordability of a franchise and how soon you’ll reach your financial goals, royalties are an important piece of the puzzle. You shouldn’t just calculate whether you can afford the initial investment–you should also calculate whether the franchisor’s royalty scale will allow you to reach your financial goals in the right amount of time. The FDD should provide some guidance to help you make these calculations.
What About Marketing Fees?
In most cases, you should plan to do at least some marketing for your own franchise, but franchisors typically also provide marketing support for their franchisees. The bigger the franchisor, the more marketing happens at the corporate level. National fast-food franchisors, for instance, spend enormous sums of money on advertising and marketing, through agencies, an in-house team, or both.
This marketing isn’t free to franchisees. In fact, if you see a “marketing fee” listed in the FDD along with other costs, this is what it’s for. Otherwise, know that marketing costs are coming out of your royalties. Some franchisors charge the marketing fee annually, while others charge it quarterly or monthly.
How Franchise Fees & Royalties Should Balance Out
National franchises generally cost more to purchase than regional ones, and certain types of franchises (e.g., national fast-food brands) are often more expensive than others. Keeping that in mind, you should see balance in the fees a franchisor charges. If you’re comparing similar franchisor types and sizes, a franchisor with a higher up-front fee should charge lower royalties. If the up-front fee is comparatively low, you should expect to pay more in royalties.
And, of course, the more you pay, the more support you should expect to receive. If a franchisor charges high franchise fees and royalties for its type and doesn’t provide additional support to make up for it, that could be a red flag. The franchisor may be in financial trouble and relying on higher-than-normal franchise fees to stay afloat.
Evaluating franchise costs is just one part of finding the right franchise for you. I’m here to help you evaluate all the factors that are relevant to your situation, so you can find your franchise match and achieve long-term success. We can get started with just a short call–book some time on my calendar today!
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