Franchise Fee: Who Pays It and Why it Matters

There are two main parties in a franchise agreement, namely the franchisor and the franchisee. While the former allows the franchisee to use their brand name and other materials provided by the corporation, a franchisee handles the day-to-day operations of the outlet and deals with most of the expenses. 

For this relationship to exist, a franchise fee needs to be paid. However, since such deals contain many moving parts, it might be hard to narrow down the direction in which the franchise fee flows.

What is a Franchise Fee?

• A franchise fee is an amount paid to enter into a franchise agreement. The franchise fee is paid by the franchisee to the franchisor.

• The franchise fee is usually a large sum, which allows the corporation to put its brand in the hands of an outsider, who then operates the outlet in the corporation’s name.

• A large franchise fee acts as security for the franchisor, as it ensures that franchisees will work as hard as they can to recuperate the investment that they made through the franchise fee.

• Apart from the franchise fee, there are also other payments that the franchisee has to make to the franchisor in the normal course of business.
  

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Costs Apart From Franchise Fee

• Owning and operating a franchise comes with expenses other than the franchise fee. This includes marketing fees and royalties.

• Franchise marketing fees are usually based on the monthly revenue, and are worked out as a percentage of the same. 

• Royalties are a percentage of the total revenue which is paid to the franchisor. Royalties can be paid either on a monthly or a yearly basis depending on the terms of the agreement.

How Franchise Fees Work

• Franchise fees start as an initial payment that the franchisee makes to the franchisor when the agreement to create the franchisee’s position is signed.

• The amount that they have to pay would be disclosed upfront as the franchise fee, in most cases, is supposed to be an immediate payment.

• Many people assume that the franchise fee is the payment that is made to secure the franchisor’s advice and material support, but this is not true. The franchise fee just allows the franchisee to enter into the franchise’s space.

• The franchisor is not bound to provide advice and support due to the payment of a franchise fee, unless it is specifically mentioned in the agreement that they will do so.

• The exact amount that would have to be paid as the franchise fee would vary from industry to industry, and would even be different for individual agreements depending on the value of the franchise and the capabilities of the franchisee.

• The aim is to strike a balance between the franchisor’s expenses and the franchisee’s financial capabilities. 

• Usually, a franchisor will set the franchise fee at a level that will enable them to market their opportunity to prospective franchisees and pay commissions to franchise salespeople, while also giving them the resources necessary to provide initial support to franchisees.

While it may seem like franchisees run these businesses at a loss due to the need to pay an upfront franchise fee, there are many sources of income for the franchisee as well. 

How Do Franchisees Get Paid?

• On the face of it, it may seem that franchisees don’t have any reason to enter into such an agreement. They have to put in a large initial investment, they may not be allowed to keep all their profits, and they have to adhere to the instructions given by the franchisor.

• Some might even claim that owning a franchise is not financially viable as a result of the payments that they must make to become franchisees in the first place. However, this is incorrect.

• Such agreements are actually greatly beneficial for franchisees. One of the primary reasons for a business failing is its inability to create a brand image. Through franchising, the franchisee can use a pre-existing brand image and the consequent brand loyalty.

• The franchisee would gain contacts in the industry that they may otherwise not have. For instance, they may be able to reliably get cheap and high-quality raw material for their business through a supplier that they would not have been able to find on their own.

• More importantly, franchisees earn money through the profit received from the sale of goods and services. Just like any other business, a franchisee can expect rewards for their labour. 

• Although a percentage of the profits might go to the franchisor through royalties, the franchisee gets to retain a large percentage of the profits. There are also other sources through which they may get paid. 

• Depending on the terms of the agreement, the franchisee may also receive a monthly salary. But this arrangement is relatively rare, as most franchises opt to keep the profits.

Responsibilities of Franchisees

• While the sources of income for franchisees might lead people to believe that it is an easy job that pays well, it is necessary to consider the responsibilities that come with the position.

• The first, and most obvious, responsibility is ensuring regular payments to the franchisor. The requisite payments must be made on time, every time, or else the franchisee’s licence to operate under the franchise’s brand could be revoked.

• As franchisees rely on the brand awareness of their franchisor, this would be a great blow to their business. Thus, regular payments are of utmost importance.

• Franchisees must also hire, train, and manage employees. Franchisees are responsible for employee remuneration as well.

• The franchisor may not always arrange a building for the franchisee to operate in. If they don’t, the franchisee has to find a place to operate the business from and enter into a separate agreement to run a commercial enterprise there.

• Even if the franchisor does arrange for a business premises, the franchisee would still have to oversee the actual setting-up and physical maintenance of the business. This includes regular cleaning, conforming to relevant food safety and hygiene standards, and other matters of practical importance.
  

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Conclusion

The franchise fee is paid by the franchisee. This is explicitly laid out in most franchise agreements, but it would apply even if it is not explicitly mentioned.

Although the brand value and support from the franchisor help considerably, the franchisee still has to lead the business to success. It is not an easy task to succeed in today’s competitive atmosphere.