Are Royalty Fees the Norm with Franchises?
I am interested in a franchise that charges a $30,000 franchise fee and takes a 6% royalty fee from gross sales. I have spoken with a few other franchise owners who say they've never heard of a royalty fee like this and that the only payment they've made is the one-time franchise fee. Can you advise?
Almost all franchises have an ongoing monthly or weekly franchise fee (commonly referred to as a royalty fee). This fee is typically expressed as a percentage of the gross sales revenue of the business with its measurement period matching the timing of the payment obligation (with a slight lag to allow for processing). For example, if royalty fee payments are due monthly, the measurement period is always a calendar month, but the royalty fee payment is typically due for the month in question by the 10th or 15th of the following month. The franchise fee can also be a fixed amount that does not vary with volume.
There are also some franchises that do not have a “royalty fee” per se but they do require their franchisees to buy products from them and/or from designated suppliers at a markup and that’s how they generate their ongoing income from the franchise operation.
When royalties are expressed as a percent of sales, most business format franchises fall into the range of 4-6%, though it can be as low as a fraction of 1% or as high as 50%. Regardless of how the ongoing fee is structured or paid, it allows the franchise company to cover the costs of ongoing services delivered to the franchisees and to provide the company with a profit from its operations. Without this fee in some form or fashion, the franchise company would probably go out of business and not be able to support the brand and its operations, which could hurt all franchisees.
The only way to evaluate if the royalty fee is reasonable is to determine the typical profit of the franchise unit after all expenses, including any royalty fees, are paid. Then you can compare this average income to the initial investment for the business and determine the expected rate of return you’ll receive. If the ROR seems reasonable (or hopefully higher than just reasonable) to you, buy it. If the rate of return for the business is not reasonable in terms of your goals, don’t buy it. Don’t allow yourself to be distracted by any one expense item. Instead, make sure the bottom line is good for you and you’ll be much safer in your decision.