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The Royalty Fees of a Franchise

Written by: Ken Hollowell

Article Overview: An indepth explanation of how a franchise royalty is evaluated.

The Royalty Fees of a Franchise

Franchises are popular with entrepreneurs who're looking to start a new small business, and for good reasons. Unlike when starting a business from scratch, where you'll have to come up with something to sell and a way to sell it, with a franchise you get the right to sell goods or use a system that the public--your customers--already knows and buys.

But, of course, the benefits come with a cost. First, you usually have to pay a franchise fee, which is an initial, upfront fee that you're charged for "joining the family," that is, just for the right to do business under the franchisor's name.

On top of the franchise fee, you'll probably have to pay franchise royalty fees or "continuing fees" or "continuing royalties," which are payments you have to make to the franchisor for the life of your franchise agreement with the franchisor. These royalty fees not only impact your initial decision as to which franchise you should invest in, but also your ongoing operation of the business. So, it's a good idea to have an understanding of what franchise royalty fees are and how they're calculated.

What's a Royalty Fee?

A franchise royalty fee is a sum of money that you agree to pay the franchisor periodically. The franchise agreement usually specifies how much you have to pay and when. Typically, the fee is based upon your sales of the goods or services that franchisor has agreed to let you sell, and more often than not it's a percentage of your sales. It's common for these royalty payments to be due weekly, monthly or quarterly.

There are, of course, other payment options and schemes. Some franchise agreements call for a pre-determined, fixed amount of royalties that you must pay, and the agreement sets a payment schedule. Or, it could be a combination of the two. For example, the franchise agreement might require you to pay either a fixed royalty, which might be a based on a percentage of your projected sales, or a percentage of your actual sales, whichever is greater.

What's the fee for? If you think of the franchise fee as the cost of joining the family, you can think of the royalty fee as the cost of staying in the family: in order to keep the privilege of doing business under the franchisor's name, you have to pay a fee. Generally, however, you do get some things in exchange for the fee.

In most franchise fees, the franchisor agrees to do certain things during the life of your franchise agreement. Typically, in the franchise agreement, they're labeled something like "franchisor's continuing obligations," or words of similar meaning. Although these obligations will vary by franchisor and agreement, they usually include things like the franchisor's agreement to:

• Train you and your employees on any changes made to the franchisor's system, process, or goods
• Update the franchisor's operating manual
• Advertise or promote the franchisor's franchisees and the products and services sold by them
• Sell to you the goods, products, or services that the franchisor controls and are necessary for the franchised business
• Give you advice regarding the operation of the franchised business, such as preparation of the goods or services in the manner provided for in the operation manual, management of supplies, styles and type of service, operation of your shop, and development of a personnel policy.

Keeping Records

Most franchise agreements require you to keep various books and records so that the amount of your royalty fees can be determined and verified by the franchisor. These might include a requirement that you make:

• A periodic statement of your net or gross sales revenues and that you submit a copy of the statement with each royalty payment you make. So, you might have to make such a report each week, month, or quarter. Usually, the franchisor has forms that you must use for this type of report.
• An annual report on your net or gross sales revenues as finally adjusted after the closing and review of your financial books and records for that fiscal year. Usually, the franchisor will require this statement to be certified by your accountant, and the franchisor will have forms for you to use for this report as well.

In addition, it's likely that you'll be required to maintain books and records that clearly and accurately show your revenue, and to keep them for a specified amount of time, which is usually several years. Also, you'll probably have to agree to allow the franchisor to examine and audit the books at any time the franchisor chooses.

If your annual report or an audit by the franchisor shows that you've under paid the royalty fees, the franchise agreement will usually provide that you must pay the amount of the shortfall immediately, with interest, which likely will be measured from the date the payment was originally due. In the case you over paid royalties, the franchise agreement will likely state that the franchisor will refund the amount immediately or credit it to your account.

Of course, repeated failures to pay or continually not paying enough might cause the franchisor to terminate your franchise agreement.

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Article Tags: franchise consultant, ken hollowell, our business, profran consultants



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