Two of the most common costs associated with franchising are initial franchise fees and royalty fees. Franchisees – especially those new to franchising – need to understand the differences between the two and why they are so critical to the launch of a location.
They also demonstrate why franchisees should be financially stable and hire a franchise lawyer before entering into a franchise agreement.
Initial Franchise Fee
The term “franchise fee” is often used too loosely in this area of business. It can easily confuse a franchisee, especially since they will incur several franchise fees. Referring to an “initial franchise fee” is a bit more on-point; the initial franchise fee is a one-time, upfront amount that a prospective franchisee pays to the franchisor for the rights to acquire a franchise, develop the location and join the franchise system. It is also frequently intended to cover the franchisor’s onboarding costs, which include:
- Initial training
- Marketing
- Any broker’s commission
- and other services that help launch the location.
The franchisor will disclose the initial franchise fee in Item 5 of the Franchise Disclosure Document (FDD). Franchisors are not required to charge any minimum amount, but initial franchise fees generally range from $25,000 to $65,000 for the right to develop one franchise.
The franchisor needs to be competitive with the price it charges as an initial franchise fee to attract the right franchisee. And while the initial franchise fee is typically not negotiable, franchisees may look at other FDDs in the same industry to compare and make informed decisions.
It should be noted that the fees listed in Item 5 do not represent all of the costs of opening your franchise. The FDD will provide more information about the other upfront expenses in Item 7 -Estimated Initial Investment.
Royalty Fees
The royalty fees are generally more akin to fees paid in connection with a trademark license, because the franchisee is essentially paying for the right to use the easily-identifiable branding inside and outside the location as well as the franchisor’s system or method of operation. It is also intended to cover the costs associated with the ongoing support provided by the franchisor.
Royalty fees typically range between 5 and 9 percent of the franchisee’s gross sales. In some cases, the franchisor may set a minimum amount, which must be paid regardless of whether your business is deriving any revenue. It is, after all, a key source of revenue for the franchisor.
Royalties are disclosed in Item 6 of the FDD. This Item details continuous and other occasional fees you may be required to pay to the franchisor (or that the franchisor imposes or collects on behalf of third parties) while you are operating the franchise. These fees may be related to marketing, software and technology, late fees, renewal fees, transfer fees, and others.
Though initial franchise fees, royalty fees and total investment costs are detailed in the FDD, it is still incredibly beneficial to hire a franchise lawyer who will walk you through each item and section. This will help provide a clear understanding of your costs and remove the guesswork. So many franchisees have circumvented legal counsel for various reasons, only to incur greater costs down the line.
We Can Help
Lusthaus Law P.C. has a proven record of assisting franchisors and franchisees with their business operations at every stage of development. We are committed to our clients’ success and keep our finger on the pulse of the industry to ensure that we provide the best and most up-to-date franchise law counsel.
Contact us today to learn more about how Lusthaus Law P.C. can help you navigate a clear path towards your franchise’s successful future.
