What Are Franchise Fees and Royalties?

Written by : Expert Article

What Are Franchise Fees and Royalties?

Technically, a "franchise fee" is the upfront cost associated with obtaining use of the franchisor's mark (its name/logo/mark) as well as numerous sundry items such as initial training, set-up, and so on. In other words, the franchise fee is the initial cost paid by the franchisee to join the system.

Now, some may refer to "ongoing fees" as franchise fees, but those are rightfully termed "royalty fees". The "royalty" is paid (usually on a monthly basis) either as a flat fee or a percentage of sales. Almost always there is an ongoing (royalty) fee paid to the franchisor, and hopefully there is real value in ongoing support services received in return. The franchisor's offering circular describes the nature of the fees as well as what services (or items) the franchisor is obligating itself to in return for the fees paid.

In the language of franchising, when you use the phrase "franchise fee," most insiders understand that to be the initial check you write to the franchisor when you sign your franchise agreement. It's the cost of joining the system and is usually a fairly large flat fee.

My sense of your question, however, is that you're really referring to all the fees-and there can be many. The principal fee in franchising-other than the franchise fee-is the royalty fee or, in some systems, the continuing royalty. This refers to the checks you'll send to your franchisor on a routine basis throughout the term of the agreement. You pay this for staying in the system. While it varies from franchisor to franchisor, the royalty is typically calculated as a percentage of your sales. You may be required to send the payment each month, each week or on some other regular schedule to the franchisor. Many franchisors today don't even need you to send them a check. When you sign the franchise agreement, you give them permission to reach into your checking account and wire transfer the payment directly to them.

Before I get mail from some franchise purists, the other routine fee is usually the advertising fee. This is the payment you'll likely make on the same frequency as your royalty payments and also as a percentage of your sales. While we call it a fee, and it is money out of your pocket, practically speaking it isn't really a fee. The advertising fee is almost always a contribution you're required to make to an advertising fund that the franchisor manages for the franchise system. The franchisor customarily uses the fund to create advertising and marketing materials or, in some cases, to actually place the advertising and often to reimburse itself for the costs of administering the fund.

Now that we've identified the two principal fees-the franchise fee and the royalty fee-why are you paying those two? Simplistically, you pay the franchise fee for the right to join the club. The franchisor won't let you into the system unless you pay him the initial fee. You pay the royalty each week or each month to stay in the club. In most well written franchise agreements, that's actually all you get-entrance and continual access.

To determine what you'll receive from the franchisor, you need to read the written franchise agreements closely. Remember, in franchising, as in most other contractual arrangements, you only get what your written contract says you get. If there's something your franchisor said they'd provide that's important to you, and it's not in your written contract, have them amend the contract. They may not be legally bound to provide you that service if it's not in the written agreements.

Also essential to remember: Don't ever-ever-invest in a franchise without the advice of an experienced franchise lawyer. Franchising is a specialty area in the law and, most general practitioners may not have sufficient knowledge to decipher a franchise agreement. Also, and maybe even more important, don't ever accept the advice of franchise brokers. They may act like your friends and even refer to themselves as "franchise advisors or consultants," but they don't work for you. They work for and get paid by the franchisor only when you buy a franchise. They have a bit of a conflict when it comes to giving you advice.