When buying into a franchise business, there are a lot of costs to consider. While this can be one of the easiest ways to start a business, depending on the franchise fees, it may not be the cheapest.
In this guide, we’ll break down what franchise fees are and how much you can typically expect to pay. If you’re a franchisor, we’ll also explain how to set franchise fees. Let’s get started.
What Is a Franchise?
Before we dive into the world of franchise fees, let’s first define what a franchise is. A franchise is a type of business license that allows a business’s intellectual property—including proprietary knowledge, processes, and trademarks—to be shared from the owner (known as the franchisor) to a third party (known as a franchisee) so the franchisee can sell a product or service under the business’s name.
According to the Federal Trade Commission (FTC), a business must meet these three rules to be considered a franchise.
- The franchisor licenses its trademarks and other intellectual property to the franchisee.
- The franchisor has significant operating control over and offers assistance to the franchisee’s business.
- The franchisee pays the franchisor $500 or more within the first six months.
If these criteria are met, the business is considered a franchise. This last requirement refers to the franchise fees that will be paid by the franchisee to the franchisor. Some popular franchises you’ve likely come into contact with include McDonald’s, UPS, and Ace Hardware.
What Is a Franchise Fee?
As we mentioned above, a franchise fee is the payment made by a franchisee to the franchisor for the use of a business’s intellectual property. A franchise fee may sometimes be referred to as an initial franchise fee, but there are more franchise fees to consider besides this one-time upfront payment.
Franchise fees include the cost to join the franchise system, as well as to continue to operate under the business’s name. Let’s explore these fees in greater detail.
Types of Franchise Fees
There are several franchise fees you can expect to pay when buying into a franchise business.
1. Initial Franchise Fee
The most common fee being referenced when someone talks about the franchise fee is the initial franchise fee.
The initial franchise fee is the first fee paid by the franchisee to the franchisor. The franchise fee is a one-time payment for getting access to the intellectual property, brand, and support of the franchisor. The franchise fee might also pay for:
- Initial franchisee training
- Franchisor site visit and development assistance
- Initial advertising of the new franchise
- Other support and training opportunities that arise as the franchisee opens and starts their franchise
The initial franchise fee is typically paid at the time that the franchisee signs the franchise agreement. The franchise agreement is part of the Franchise Disclosure Document (FDD) which must be shared from the franchisor to franchisee at least 14 days prior to signing the documents. The initial franchise fee must be disclosed in the franchise agreement, along with any other ongoing fees that will be charged by the franchisor.
To qualify as a franchise, the initial franchise fee can be anything over $500. On average, the initial franchise fee ranges from $10,000 to $50,000. Keep in mind that while this initial fee is substantial, it’s merely the first of many franchise fees you’ll be responsible for paying over the life of your business ownership.
2. Royalty Fee
The royalty fee is a fee paid by the franchisee to the franchisor on a set schedule throughout the term of the franchise agreement. A royalty fee, also called a continuing royalty fee, is the franchisor’s cut of the profits made by each of their franchisees.
This franchise fee is paid on a set schedule—depending on the terms of your agreement, it might be paid weekly, monthly, quarterly, or annually. The amount of the royalty fee is determined by the franchise agreement. It’s typically based on a percentage of the franchisee’s gross or net revenue.
Therefore, if you have a yearly revenue of $100,000 and your royalty fee is 3%, you’ll owe $30,000 to the franchisor for the use of their brand, products or services, etc.
3. Marketing Fee
Another ongoing franchise fee you can expect to pay is a marketing or advertising fee. This is typically a monthly fee calculated as a set percentage of your sales that goes to the franchisor for their advertising and marketing efforts.
One of the perks of opening a franchise business is the name recognition. Everyone knows McDonald’s, for example, so you automatically have an established customer base when you open your franchise. However, the franchisor is likely paying top dollar in their marketing efforts, whether it’s TV and radio commercials, brand partnerships, social media campaigns, or more. And as a participant in the franchise, you are expected to contribute your part for these marketing efforts. The good news is, this will likely be the only marketing you need to do for your business, and you don’t have to worry about the logistics yourself.
4. Renewal Fee
The franchise agreement establishes a set timeframe in which the franchise relationship between the franchisee and franchisor stands. At the end of that term, you’ll need to decide whether you’ll renew the agreement or dissolve the relationship.
If you decide to renew the franchise agreement, you will then need to pay a renewal fee to the franchisor. In general, the renewal fee will be lower than the initial franchise fee.
A renewal fee may also be known as a successor fee.
5. Transfer Fee
If the time comes when you no longer want to own a franchise business, you’ll have a few options. One of those options may include transferring your franchise agreement to another owner. If you transfer ownership to another franchisee, the new franchisee will have to pay the franchisor a fee.
The transfer fee should be lower than the initial franchise fee.
Typical Cost of Franchise Fees
Just like franchises and franchise agreements, the franchise fee is different for every industry, for every franchisor, and for every franchise. The franchise fee is set so that the franchisor can be competitive within their market, pay commission to salespeople, and be able to provide all of the resources necessary to franchisees.
In general, an initial franchise fee can range from $10,000 to $50,000. Even the best low-cost franchises take a heavy initial investment. And if you’re looking to purchase a large geographic area and resell multiple franchises in that area, it can cost $100,000 or more. This is known as a master franchise.
While the initial franchise fee may seem like a lot, it’s important to remember that it’s not the only cost of starting a franchise. Most franchise agreements include a financial disclosure from the franchisee to the franchisor. The franchisee must have a certain amount of liquid cash for initial operating costs and finding a brick and mortar space.
The total upfront cost of starting a franchise, then, including the initial franchise fee and all other expenses, can be $175,000 or more. When looking to invest in a franchise, don’t just look at the initial franchise fee, be sure to look at the estimate for the total upfront cost. If it’s not included in the franchise agreement, be sure to ask the franchisor for an estimate.
On top of your franchise fees, don’t forget to calculate your other startup costs to make sure you have a complete picture of what it will take to start your franchise. And if you don’t have this capital in your savings alone, take a look at your franchise financing options to see if a loan can help make your franchise dreams a reality.
How to Set Franchise Fees
If you’re in the position of setting the franchise fees for your business—in other words, you’re the franchisor—you may be wondering how to determine what’s an appropriate amount. Choosing the cost of your franchise fees is dependent upon a lot of different factors. In general, as the franchisor, you want to set a competitive price that can reasonably be paid by your franchisees.
Before setting your fees, you’ll want to do your research and consider the following factors:
1. Fee Charged by Competitors
One of the first pieces of research you should do is to find out the fees charged by your competitors. In knowing what your competitors charge, you can set a competitive price. This not only helps you set the price of your franchise fees but to position yourself within the marketplace.
2. Age of Franchise Operation
The age of your franchise can be part of the equation when determining the price of your franchise fees. As a new franchisor, you may not have a lot of options for prospective franchisees or be able to make a large profit from an initial franchisee.
Keep this in mind while drawing up the terms of your franchise agreement. If your business is just getting started and you’re unsure what kinds of profit to expect, limit the terms to a year or two so you can revisit your fees once you have a better idea of the demand for your business.
3. Multi-Unit Development
If a franchisee wants to open multiple locations within a defined period of time, this is called a multi-unit franchise. If a potential franchisee is going to agree to a multi-unit development of franchises, you might want to reduce your initial franchise fee to incentivize this larger undertaking.
4. Initial Franchise Member
A new franchisor might offer a reduced franchise fee for the initial members of their franchise. Keep in mind, while you’re taking a risk on the franchisee, the franchisee is also taking a risk on you and your new business. As such, you may offer a lower price to help drive interest in your franchise.
This is sometimes known as a founder club. The initial five or even 10 franchisees receive a discounted franchise fee to get the business rolling efficiently.
Franchise Fees: The Bottom Line
From the viewpoint of the franchisee, the fees associated with buying into a franchise business are critically important to their decision to open the business in the first place. Not only are these costs significant, but they aren’t the only ones to consider when starting a business.
From the franchisor’s perspective, these fees are one of the ways they make money. Setting a fair price that’s based on your competitors, how established the franchise is, and how many units the franchisee plans to open can help you set a fair price that will bring in franchisees that will help make the business successful.