When you own and operate a business, you can expect to incur various costs. And if you invest in an independent startup, there’s no definitive way to determine the exact costs you’ll face. In comparison, the costs of investing in different franchise opportunities are much easier to define, since they’re clearly spelled out in items 5, 6, and 7 of the companies’ Franchise Disclosure Documents (FDDs). These are the documents that franchisors must provide to prospective franchisees to comply with rules established by the Federal Trade Commission (FTC).
Before you begin comparing franchise opportunities, though, you should have a good understanding of the types of fees you can expect to pay. Here, we’ll look at the franchise royalty fee and how it’s calculated.
Why Do Franchise Companies Charge Royalties and Other Fees?
When you buy a franchise, you enter into a financial relationship with another business, which is clearly defined in the franchise agreement you both sign. By signing, you agree to follow the company’s established procedures and pay specific franchise fees in exchange for the right to use their brand name and other proprietary assets.
You might think of it as joining an exclusive club—where you pay an initial sum to become a member, as well as ongoing fees to maintain that membership. In a franchisor/franchisee relationship, the franchisor uses these fees for different purposes:
- One-time franchise fee: This initial fee covers a franchisor’s startup expenses—such as training, assistance with site selection, lease negotiations and build-out, staff recruitment/training, marketing, and any other costs associated with launching a store.
- Recurring royalty fees: Recurring royalties are typically used to defray the ongoing expenses incurred by a franchise company. These expenses might include updates to operation manuals, field support, administrative costs, staff salaries, new franchisee recruitment, product research/development, and brand expansion.
How Are Royalty Fees Calculated?
The exact method used to calculate royalties and how often they’re payable can vary greatly between franchisors, so it’s wise to take a close look at the descriptions listed in the FDD of any franchise opportunities you’re seriously considering. In general, there are four main methods used to calculate franchise royalty fees:
- Fixed fees
- Percentage of gross revenue
- Percentage per transaction or item sold
- Split profits
Fixed royalty fees are set amounts paid to the franchisor on a weekly or monthly basis, regardless of a franchisee’s sales or income. With this type of royalty, the franchisor may include a provision that allows them to adjust the fee amount.
Percentage of Revenue
If a franchisor charges a royalty based on a percentage of revenue, franchisees pay a set portion of their gross income during a specific period, usually weekly or monthly. Some franchise companies charge sliding percentages that increase or decrease depending on sales revenue. Even if the royalty is a set percentage, the exact amount a franchisee pays can vary, since it’s tied to their store’s income.
Percentage Per Item or Transaction
This method is similar to percentage of revenue royalties, but it’s based on individual transactions instead of gross revenue. Franchisors who charge this type of royalty often have their franchisees use point-of-sale systems that do the calculations automatically.
Split Profit Royalties
Split profit royalties are not very common, largely because they’re viewed less favorably by franchisees. With this method, the total profits of a location during a defined period are split between the franchisee and franchisor at an agreed percentage, such as 40/60.
To learn more about the benefits and costs of investing in a Signarama franchise opportunity, contact us today.