Cost of buying a franchise - the franchise fees

Some franchisors charge a deposit that may be fully or partially non–refundable. Often the deposit is used to research the territory or to help you find a suitable property. If you can't find a property within an agreed period the deposit is usually refundable less the franchisor's reasonable costs. In other circumstance, unless the deposit is for a nominal sum, or the franchisee gets something for their money, such as a specific territory reserved for them, the deposit should be refundable. Franchisees must make sure that before they part with a deposit they receive a written confirmation from the franchisor that:

• if the franchisee goes ahead and signs a franchise agreement, the amount of the deposit will be credited towards the payment of the initial franchise fee; and
• the precise circumstances under which it is non-refundable/refundable with the appropriate time limits.

Initial Franchise Fees

The initial fee varies from company to company and is paid by the franchisee when the franchise is granted. The initial franchise fee covers the cost of training, recruiting, territory analysis, site identification, specialist equipment, stationary, franchisee launch, etc. In addition, there will be an element of recovery of franchise development costs by the franchisor.

On–going Franchise Fees

The on-going franchise fee is usually based upon a percentage of the ‘gross revenue’ or sales of the franchisee after deducting VAT. There is no set formula; rather it depends on the split of responsibilities between franchisee/franchisor. The more the franchisor does the higher the fee. In some cases there will be no on-going fee – it will be covered in a mark-up on the product. There are also cases where the franchisor will justify an increase in fees on issues such as extra start-up costs and inflation. In any case the type of fees to be paid, its regularity and whether it can be increased or decreased should correctly reflect the services the franchisor will provide, and should be properly communicated to the franchisee before the franchise agreement is signed.

You therefore need to know:

• How much the royalty fee is?
• How often it is to be paid?
• Is it a percentage or fixed amount?
• If a percentage, what is it based on?
• How does it compare to other franchise systems?

Advertising Fee

Advertising fees are used to advertise the franchise system. Normally an advertising fee is based upon a percentage of gross sales or net sales (though it can sometimes be a stated amount). They typically range from 1% to 5% of gross sales.

The fees are often put into a regional or national fund to be used for either regional or national marketing or advertising campaigns. Franchisors in their start-up phase may not ask for an advertising fee to be paid, as they would not expect to achieve any real benefit, i.e. in terms of increase in sales or brand awareness, via a regional or national campaign. They will however expect the franchisee to pay for local advertising to promote their franchise.

You need to know:

• What the fee is?
• Is the same fee paid throughout the network?
• How it compares with other systems?
• What you get for your money?
• If the franchisor can spend the fee on how they see fit?
• Will an advertising fee benefit the system?
• Or your franchise?

Other Issues

• The greater the perceived reputation of the franchise, the higher the initial fee.
• The greater the reliance on the franchisor's efforts and support, the higher the fee.
• Renewal fee is when a franchisee is charged a fee by the franchisor on granting an extended contract term.
• Transfer fee can be charged when the franchisee sells the outlet to another person.
• Where on-going fees are absent they are normally substituted by mark-ups or rebates on products supplied to franchisees normally substitute them.
• On-going fees are structured as a percentage of turnover, but in some cases a flat weekly or monthly payment is charged.
• Advertising or marketing fees are often collected for the promotional activities on behalf of the whole network.
• ‘Special’ fees may also be charged by the franchisor for services such as training in the use of new software.