How Do Franchise Royalties Work? Tips For Prospective Franchisees

How do franchise royalties work? When pondering the idea of buying a franchise, a proper understanding of just how franchise royalties work is critical. Royalties are ongoing fees paid to the franchisor for the use of a proven brand, systems, manuals and other proprietary information. 

But the manner in which these fees are calculated and collected can vary, rendering it important to understand exactly what it is that you are paying for.

Expert Insight

David McDougall, Managing Partner of DGM Business Advisors, has decades of franchising experience explains that royalties generally consist of a percentage of sales or revenue (though other fees may also apply). 

“Paying royalties is like paying a utility bill,” McDougall said. “You ask yourself, ‘What am I getting for this in return?’ Royalties are for the use of proprietary marks and operating systems. The franchisor invests in the brand to grow sales while the franchisee uses the tools locally to build business,” McDougall said. “Other things may include specific proprietary products or services the franchisor provides – which could be another way to collect fees.”

Understanding Royalties

How do franchise royalties work? Understanding that goes beyond merely knowing a percentage rate. Here are the key concepts worth pondering:

1. Know the Structure – Royalties are most commonly based on sales and are calculated weekly, bi-weekly or monthly. Ensuring that the franchisor provides a clear draft showing specific amounts and calculations is critical.
    
2. Identify All Fee Sources – Beyond royalties, fees may also come to include marketing contributions, technology charges and required vendors with whom potential franchise owners must work regardless of cost. A thorough review of the FDD is a necessary step toward developing a full understanding of financial obligations.
    
3. Check Minimum Requirements – Some systems require a minimum royalty regardless of the revenue coming in. Being aware of these extra obligations, particularly for new or low-volume locations, is key.
    
4. Ask Questions – The idea of royalties can be tricky. Reading an FDD can be trickier. Asking questions is an integral part of developing a full understanding of the royalty structure that’s unique to each franchising opportunity. “The hardest part is asking, ‘What am I getting for the royalties?’” McDougall said. “The reality is, you bought into the system as it exists.”

The Takeaway

So, how do franchise royalties work? It’s not a simple answer. But a proper understanding is crucial when it comes to making informed decisions (and avoiding surprises). A careful review of the FDD and franchise agreements helps. But by leveraging expert advice, prospective franchisees can confidently determine whether each unique franchise opportunity is in alignment with specific financial goals.

Franchise royalties are an ongoing commitment. But by performing due diligence and approaching each situation with clarity and realistic expectations, zees can ensure the fees support, as opposed to hinder, success in franchising.

Want to learn more about franchise opportunities on 1851 Franchise? Be sure to visit our Power Rankings to read more on brands making moves.