What are included in the franchise fees?
For those considering delving into the world of franchising, it’s crucial to grasp the concept of franchise fees and what they encompass. These fees, levied by the franchisor, can be divided into two primary categories: initial franchise fees and ongoing franchise fees. Below, we delve into each category to provide clarity on their respective scopes.
Initial Franchise Fee: The initial franchise fee is a one-time payment made when entering into a franchise agreement. By paying this fee, franchisees gain access to the franchisor’s business system, brand name, trademarks, operational manuals, proprietary materials, and software, where applicable. The specifics regarding this fee are typically outlined in Item 5 of the franchisor’s franchise disclosure document (FDD).
Various factors influence the determination of initial franchise fees, including the complexity and uniqueness of the system, anticipated return on investment, development costs, and the franchisor’s expenses related to franchise acquisition. While the components covered by this fee may vary across franchise companies, examples of what the fee often includes can be found in our Signarama franchise, such as:
1. Initial training
2. Assistance with location selection and lease negotiation
3. Support for site build-out
4. Access to suppliers
5. Recruitment and training aid for employees
6. Assistance during store ramp-up and launch
7. Support from staff during grand opening
8. Startup marketing kits
To ascertain the reasonableness of the franchise fee, potential franchisees should compare it with the expenses associated with starting a similar independent business and the costs of acquiring requisite skills and third-party services.
Ongoing Franchise Fees: Once the initial fee has been paid and the franchise is operational, ongoing fees become pertinent. The two primary types of ongoing fees imposed by franchisors are royalties and advertising fees, supplemented by other potential charges outlined below:
Royalties: Typically calculated as a percentage of weekly or monthly gross sales, royalty fees are recurring payments made by franchisees over the franchise agreement’s duration. These fees often cover updates to operational manuals, ongoing support, and resources provided by the franchisor. The specifics regarding royalty fees, including the percentage, frequency, and potential adjustments, are detailed in Item 6 of the FDD and the franchise agreement.
Advertising Fee: Designed to promote the franchise system as a whole, advertising fees may be structured as a percentage of the store’s gross or net sales or as a fixed monthly sum. These fees are pooled into regional or national funds and utilized for advertising campaigns, promotions, or marketing initiatives. The franchisor’s methodology for calculating and utilizing advertising fees is elucidated in Item 6 of the FDD.
Additional Fees: The FDD may also shed light on other charges levied by the franchisor, such as renewal fees applicable when extending the franchise contract beyond the original term or transfer fees associated with selling the franchise to another party.
Brief Conclusion
Franchise agreements typically entail several fees, including an initial fee, a management service fee (commonly known as royalty), and an advertising fee. The franchisee is usually obligated to remit an initial fee to the franchisor before or upon signing the franchise agreement. This initial fee encompasses various provisions, such as providing an operations manual, offering practical training, and furnishing a startup package comprising equipment, uniforms, stationery, product inventory, and shop fittings. Additionally, expenses incurred by the franchisor on activities like market research, planning, professional services, and franchisee recruitment are typically covered within the initial fee and subsequently passed on to the franchisee.
Furthermore, the franchisee is expected to pay an ongoing fee to the franchisor, often referred to as a franchise fee, management service fee, service fee, or royalty. This payment facilitates continued access to the franchisor’s goodwill, brand reputation, established brand name, and trademarks. Additionally, franchisees can anticipate ongoing training from the franchisor regarding any updates or enhancements to the franchise system. While this ongoing fee may encompass contributions to marketing and advertising expenses, an advertising fee is frequently collected separately from the ongoing franchise fee.