What Is a Franchise Royalty Fee?
Royalty payments play a crucial role in the financial relationship between the business owner and a new franchise. Prospective franchisees should familiarize themselves with the initial fee and ongoing payment requirements outlined by their franchise system.
What Are Royalty Fees?
A royalty fee is a payment that a franchisee makes to its franchisor. This payment is how the franchisor earns money from its franchises. The payment allows the franchisee to operate their business using the franchisor’s intellectual property, including its brand, trademarks, and business model. In exchange, the franchisor may use these royalties to pay for marketing fees across the entire franchise system, introduce new products, provide training, and cover other franchise costs.
As you pursue franchise ownership, look for information about franchise fees in item 6 of the company’s Franchise Disclosure Document (FDD). This item covers "Other Fees," including the amount or percentage of revenue that’s paid as a franchise fee. It explains how the fee is calculated and outlines its payment terms. The FDD will also formally specify what services a franchisee receives in exchange for the royalty payment, such as advertising, operational support, and ongoing assistance.
One-Time Franchise Fee and Ongoing Royalty Fees
Franchise agreements usually outline two types of royalty fees: one-time fees and ongoing fees. The franchisor is required to pay both fees, and they serve different purposes.
One-Time Franchise Fee
A one-time, initial franchise fee is a preliminary payment to the franchise owner. This initial investment helps cover startup costs and gives the franchisee the right to use the franchise business's brand, trademarks, and business model. Unlike ongoing royalty fees, this is an upfront, one-time payment.
Ongoing Royalty Fees
Ongoing royalty fees are regular, recurring payments made by the franchisee to the franchisor throughout the franchise agreement. These fees are usually calculated as a royalty percentage of the franchisee's gross sales or revenue. The franchisee pays these fees on a weekly or monthly basis. And, unlike a one-time franchise fee, the ongoing royalty fees continue for the entirety of the franchise relationship.
How Much Should a Franchisee Expect To Pay in Royalty Fees?
The franchise royalty fee is usually calculated as a percentage of the franchisee's gross sales. It might seem like a lot of money. Still, the fee covers ongoing support and services the franchisor provides, including marketing support, training, operations, and the continued use of the established brand.
There is a wide range of royalty fees across industries, ranging from 3% to 13%, with a median median royalty fee of 5.00%, according to FRANdata and BizBuySell. The retail stores industry has a relatively low median minimum royalty fee of 3.21%, while the business-related and automotive industries have higher-than-average median fees of 13.88% and 9.36%, respectively. These wide range of royalty fee percentages underscore the industry-specific dynamics when determining royalty fees for franchises.
Are Franchise Royalty Fees Negotiable?
Franchise royalty fees are not always negotiable. It largely depends on the terms outlined in the franchise agreement and the franchisor policies. Some policies are stricter and more structured than others, making negotiation difficult. Those franchisors may have a case for a standardized fee structure that ensures consistency across its franchise brand. Other franchisors may allow negotiation of certain terms. For example, an experienced franchisee or one opening multiple franchises may have leverage to negotiate the royalty fee after proven performance.
Penalties for Not Paying Royalty Fees
Most franchisors impose consequences for franchisees who fail to make royalty payments. These penalties are usually outlined in the franchise agreement and commonly include:
- Late fees and interest charges. The franchise agreement may enforce a late fee if a royalty payment is overdue. In addition to late fees, some franchise agreements may charge interest. The contract will clearly define the fees, interest charges, minimum payment, and payment grace period.
- Temporary suspension of support. If a franchisee falls behind in royalty payments, the franchisor may suspend certain support services or stop making additional franchise investments until the outstanding payments are made.
- Notice of default. Persistent non-payment forces the franchisor to issue a notice of default. This notice outlines the terms and time period for a franchisee to resume payments and remedy the debt.
- Agreement termination. Continued non-payment after the notice of default can lead to termination of the franchise agreement. The termination provisions in the agreement outline the conditions under which the franchise business can terminate the relationship with a franchisee.
Navigating the franchising landscape requires prospective franchisees to have a deep understanding of franchise royalty fees. These fees, which include both upfront payments and continuing royalties, create a financial relationship that benefits both the franchisee and franchisor. Franchisees gain a comprehensive understanding that equips them to make informed decisions as they begin their entrepreneurial journey in the franchising industry.
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