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Franchise fees are typically paid for the use of the franchisor’s “system”. Fees vary a good deal from franchisor to franchisor.
Initial Franchise Fee
There is usually a one-time initial franchise fee as well as a royalty, or ongoing fee. The royalty fee is usually a percentage of the gross sales from the franchised business, but in some cases may be a flat fee paid monthly. The initial franchise fee varies a good deal from franchisor to franchisor. The initial franchise fee covers the cost of franchise development, and recruiting.
Royalties
Royalty fees will vary from 5 percent to 10 percent of gross sales. Service type franchises tend to have higher royalties than do retail franchises. The more well know the brand the higher the royalties will be. Royalties allow the franchisor to provide ongoing service and recoup their investment. Royalties need to be affordable for the franchisee but large enough for the franchisor to maintain and grow market share. A flat fee royalty is sometimes used as it is attractive to the franchisee. Product fees are another type of royalty used at times when products are distributed by the franchisor. Royalties are usually non-negotiable and consistent throughout the system.
Advertising Fee
Also, there is a fee for advertising which the franchisee pays allowing the franchisor to advertise nationally or regionally, and promote the brand. Advertising fund fees will vary from 1 percent to 4 percent of gross sales, and in some cases is a flat fee. Advertising fees are calculated in the same way as the royalty’s fee. The advertising fund fee is not considered income to the franchisor but rather collected “in trust” to promote the brand with advertising that might have been affordable otherwise.
Be sure that all advertising complies with consumer protection laws. The FTC has recently posted guidelines for online advertising. They are well written and can be accessed from their website: http://www.ftc.gov/bcp/edu/pubs/business/ecommerce/bus41.pdf
Note: All franchise fees should be debited electronic fund transfer! Don’t rely on your franchisees to send in their fees, debit them weekly or monthly.
There will typically be some fee when it comes time to renew the franchise agreement, this will typically be called a Renewal Fee. This fee must be defined in the franchise agreement. The renewal fee is usually a percentage of the franchise fee, and is usually between $3,000 and $15,000 paid in full at the time of entering into the new franchise agreement for the renewal term. The renewal fee is thought to represent the opportunity cost lost by not awarding the franchise territory to someone else at the current initial franchise fee. A low renewal fee could show that the franchisor values its franchisees and retaining their relationships verse placing a high value on its brand. Many franchisors will write in the franchise agreement that upon renewal, there will be a requirement to upgrade or modernize. Disclosure documents are not usually required; if there has been no interruption, or material change in the operation of the business.
Terms
All franchise agreements have a fixed term. The length of the term will vary from franchisor to franchisor, but the length of the term will be specified in the franchise agreement.
Usually the term is 10 years, but sometimes as long as 15 to 20 years. The term should be long enough for the franchisee to have a return on his investment. At the end of the term there is usually an option to renew, if the franchisee meets certain renewal conditions.
A typical statement used in a franchise agreement would read something like this:
The Franchise is granted to you for a term of ___ years (00) from the date that this Agreement (the “Agreement”) is executed. It is subject to earlier termination as herein provided. It will automatically terminate on the _______ (00th) anniversary of the date of this Agreement, subject to your right of renewal as herein provided.
Disclosure Document
A Disclosure Document and Franchise Agreement are needed to Franchise. The FDD or Franchise Disclosure Document has replaced the older UFOC. The Franchise Agreement is the legal agreement between the franchisor and franchisee.
It stipulates the assigned franchisee territories, as well as all fee structures, that have to be paid. It also lists the obligations of the franchisee and the franchisor. Most disclosure documents and franchise agreements have been drafted carefully to favor the franchisor. They are the cornerstones of the franchisor – franchisee relationships.
Disclosure documents are a summary of the information needed to be disclosed, or “revealed” to the prospective franchisee in for the franchisee to make an informed decision concerning his investment in a franchise. Some states called, “Registration States” control franchising through their respective securities departments. In the USA the Federal Trade Commission and their subsequent rulings control franchising. In Canada, a disclosure document to is only required in the provinces of Alberta, Ontario and PEI. The disclosure document must be provided 14 days prior to the potential signing of any franchise agreements.
Franchise Agreements
Franchise agreements will map out the protected territories of the franchisees. The franchise territory may be defined by distance, zip codes, or even cities.
The boundary lines are stated in the franchise agreement and usually will disallow the sale by the franchisor of any other franchise in this area. The franchise territory protects the franchisee from sales being made by other locations offering the same products and/or services as the franchisee. In some franchise agreements it may be stated that the territory is non-exclusive, if this is so it should be clearly so stated. It will be a source of litigation, if not clearly stated. It is important to note that franchisors are becoming more reluctant to grant exclusive protected territories. Some franchisors will right in a “Right of First Refusal” allowing the franchisor to open another franchise location within the franchised area, if provided the first franchisee is given the opportunity to open the second location and refuses to do so.
What if the franchisee is referred business outside of his territory? This is usually addressed by the franchise agreement stating that the franchised territory is the franchisees primary market of responsibility and the franchisee may only advertise in the defined territory. Otherwise, the franchisee is allowed to make sales based upon previous customer relationships or even referrals. Sometimes this definition is expanded to include sales generated by networking or even advertising done from within the franchisees franchised area.
It might be mentioned that there are sometimes sales quotas needed to maintain the franchise grant. These are written into the franchise agreement; if quotas are not met the franchisee looses the franchised area, or perhaps the franchise itself.
As a word of advice, I would advise the new franchisor to divide territories by zip code areas. This is easily accomplished using a zip code data base, which can be acquired easily. Some franchisors will use DMA’s and complicated methods of granting territories or “franchised areas” but the task need not be complicated. The new franchisor can track territories using a simple spreadsheet.
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Related articles
- 2012 Franchise Disclosure Document (thebusinessstartupkit.com)
- Franchise Your Business (thebusinessstartupkit.com)
- Franchise Operations Manual is the Corporate Guidebook (thebusinessstartupkit.com)
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