When purchasing a franchise business, there are a couple of fees that you should expect to pay. Typically there is an initial fee usually referred to as the Initial Franchise Fee. In addition to this, there is normally a recurring fee that is typically due weekly or monthly. This fee is referred to as the royalty fee.
So, what exactly is this royalty fee? Well, if you’re a franchisee, expecting to become one, or debating on becoming one, this article is made for you.
In this article, you will learn everything you need to know about royalty fees in your franchise business including what they are, how they work, why franchisors charge royalty fees, how they are calculated and why you’re expected to pay them.
What is a Royalty Fee?
A royalty fee is an ongoing payment that a franchisee pays to the franchisor. Almost all franchise systems require an ongoing fee from their franchisees. This is how it works:
The franchisor develops the initial business and goes through many iterations of their business model until they have a successful model ready for expansion. Many owners at this point decide to convert their business into a franchise operation. Once a franchise system, the owners can continue to open new locations on their own (known as Company Owned locations) or under a franchise agreement, license the rights to others to open similar businesses in other locations (known as Franchise locations). The individuals that buy these franchises are referred to as Franchisees.
A royalty fee is a recurring charge, usually on a weekly, monthly or quarterly basis, where the franchisee pays the franchisor for the continued use of the franchisor’s marks, systems, products, and services.
Now, you may be asking yourself, “Why would someone continue to pay royalty fees after they’ve paid a significant upfront fee to purchase this franchise?” Continue reading and we’ll explain why.
Why Do Franchisors Charge Royalty Fees?
Here are some reasons why franchisors charge ongoing royalty fees:
On-Going Trainings. Franchisors typically provide a lengthy and comprehensive initial training in order to teach their new franchisees everything they have learned for launching and operating this business. The costs associated with the initial training is usually covered by the initial franchise fee collected from new franchisees. However, franchisors typically provide several on-going pieces of training while franchisees are operating their business. Training franchisees in new products or services, improving customer services systems, new equipment, and new marketing methods are just some of the things a good franchisor will continuously provide on an ongoing basis. Royalty fees help absorb the costs for such training.
Ongoing Support. Franchisors have a vested interest to help their franchisees with their business. It could be as simple as being available to answer questions or offer guidance. Providing and maintaining this support network costs money, and the royalty fees help pay for these costs.
Marketing and Advertising Material. Franchisors provide updated and new and advertising material to their franchisees in order create brand continuity at all locations, no matter who owns them. Some franchisors may offer logistical support – such as accounting, payroll, supplies, or distribution. Royalty fees help offset the cost of production of such marketing material or maintaining the support.
Earn Money for their Providing a Proven Business Model. As the original
entrepreneurs that successfully launched the first business, franchisors deserves to be compensated for their efforts. They created a proof of concept, worked out the issues and made it scalable.This is no easy feat! Because the founder assumed all of the risk, paid for all the mistakes along the way and built a successful business, the franchisor is entitled to a royalty.
Monetize intellectual property. The company’s intellectual property is an important part of what makes their business scalable and able to be franchised. The royalty fee is a small fee paid by franchisees to franchisors for the right to use the marks and the company’s intellectual property.
Skin in the Game. Royalties are typically calculated as a percentage of the franchisee’s sales. This ensures that the franchisor has a vested interest in the success of its franchises. It ensures that franchisors provide the best support and the highest quality training for their franchisees.
How Are Royalty Fees Calculated?
To properly determine how a royalty fee should be calculated, first decide how the royalty will be structured. There’s two common ways that royalty fees are structured:
The first type is a flat royalty. Franchisees pay a set amount, regardless of how much business they do. Structures like this tend to pay out on a monthly basis.
Flat royalties typically more advantageous for franchisors because it guarantees them a steady residual paycheck. Some franchisees prefer flat royalties as they provide an easier easily accountable line item – a steady expense for each month. Difficulties come when franchisees sales are down and they still are required to pay the same royalty.
The second kind of royalty structure is about having a vested interest in franchisee’s business. In this model, which is typically what most franchisors use, the franchisor charges a monthly or weekly fee equal to a percentage of the franchisee’s gross sales.
A common percentage for many industries is a 5-8% royalty on the total gross sales. In some cases, a franchisor may have a minimum fixed amount that has to be met monthly.
This business model can be best for both parties because it is based on sales. The way the business performs decides how much money everyone makes. All parties are motivated to improve the sales. The downside to this arrangement is no fixed amount, and/or less cash flow for the franchisor to cover ongoing costs.
Royalty Fees are a Normal Part of All Franchise Agreements
So, there you have it! We hope this article has helped you gain some clarity on royalty fees, what to expect from them, and why they are so important in a franchise business.
Franchise Creator is here to help you become a successful franchisee and we love hearing from you! If you have any questions about royalty fees, buying a franchise or starting your own franchise, give us a call or message us on Facebook!