Franchise fees are among the most crucial financial obligations to understand before buying a franchise. The initial franchise fee often receives the most attention, but it is only one part of the total cost of becoming and remaining a franchisee. The franchise disclosure document (FDD) identifies many payments you may owe to the franchisor, its affiliates, or third-party suppliers. Let’s review some top tips to help you strategize and avoid unpleasant surprises.
The Initial Franchise Fee Is Only the Beginning
The initial franchise fee is generally disclosed in Item 5 of the FDD. The franchisee pays the initial fee before the unit opens and may cover certain services provided by the franchisor, such as assistance with location selection, business development, initial training, launch support, or marketing.
Franchisors are not required to charge a minimum amount, but initial franchise fees are generally as low as $25,000 and can go as high as $70,000 (or even more). This does not represent the entire amount needed to open the business. Item 7 of the FDD provides additional information about the estimated initial investment. Typical investment costs identified in Item 7 include real estate, construction, equipment, inventory, technology, permits, insurance, professional services, payroll, and other start-up expenses.
Additional Upfront Payments May Apply
In addition to the initial franchise fee, you may owe separate amounts for required equipment, inventory, software, training, signage, uniforms, supplies, or other products and services. Some payments may be made directly to the franchisor or an affiliated company, while others may be paid to approved third-party suppliers.
Inquire about whether these purchases are mandatory, if prices are set by the franchisor, and if the agreement allows you to use alternative vendors. Supplier restrictions and required purchases can significantly affect your opening budget and operating margins.
Royalties May Continue Regardless of Revenue
Royalties are recurring payments made for the right to use the franchisor’s trademarks, services, business model, and operating system. They are often calculated as a percentage of gross revenue – typically between 5 and 9 percent – although some franchise systems impose a fixed amount, a minimum royalty, or the greater of a percentage-based fee and a minimum payment.
A minimum royalty deserves particular attention. If your business generates little or no revenue, you will likely still be required to pay the minimum amount. This obligation can create financial pressure during the opening period, seasonal downturns, or other periods of weak performance.
Advertising Fees May Be Separate
Marketing or advertising contributions generally represent your payments to the franchisor’s brand-wide fund to be used by the franchisor in connection with advertising the brand. These amounts, which are in addition to royalties, are often a percentage of revenues.
Before investing, determine how the advertising fund may be used, whether the franchisor must spend the money in your market, and whether local marketing expenditures are also required. Brand advertising may benefit the entire franchise system, but it does not necessarily guarantee customer traffic or profitability at your location.
Thoroughly Review the FDD for Occasional Charges
Item 6 of the FDD describes recurring and other occasional fees imposed by the franchisor, its affiliates, or third parties. These include the aforementioned royalties, technology charges, renewal fees, transfer fees, audit costs, late fees, training fees, and other administrative expenses.
Do not evaluate a franchise’s potential solely by its initial fee. By reviewing Items 5, 6, and 7 in tandem, and along with a franchise lawyer, you can compare the disclosures with information from current and former franchisees, and consult experienced franchise counsel before signing.
Hiring an experienced franchise lawyer is the first step in understanding the full fee structure, which is essential to determining whether the opportunity fits your financial appetite and strategic goals.
Contact Lusthaus Law
Lusthaus Law’s website is a resource for New York franchisors and franchisees. We have published two downloadable and complimentary e-books and our Insights blog is regularly updated to reflect industry trends, legislative updates and recent achievements in client representation.
Contact us today to learn more about how Lusthaus Law P.C. can help you navigate a clear path for your franchise’s successful future.
