Nick Powills: Royalties are Greater Than Fees

Typically, it’s not the sales team’s fault that many franchisors budget around fee success. It’s just not. Someone toward the top of the organization sets a goal (typically created with limited data) and places extreme pressure on the franchise sales team to go accomplish that goal.

But, for brands that will sell someday (and, let’s not forget, every brand will have an event), this is the wrong way to look at things. Why? The value of your brand will be built on:

1. EBITDA
2. EBITDA from royalties
3. Royalties from franchisees
4. Franchisees who are successful drive more royalties

Fees are not magical numbers, either. Fees come from qualified franchise prospects who decided to buy your brand (hooray). But getting those fees is not as simple as spending $10,000/per deal in marketing and signing that franchisee. Let’s pretend that every checkmark is worth an additional $5,000 in cost to push through prospects:

1. You are an emerging brand (under 50 locations)
2. If you take a good look in the mirror, you know your unit level economics are not superior in the category
3. Validation is less than 80 percent
4. If asked, your top performers would say hold on buying the brand
5.  You have battled a public crisis within the last 24 months (if you look in Google News, it isn’t all clean)
6. It’s taking you more than a year to find real estate and build out the location

That’s just a starting point. As you can see, your costs to get those “fees” will increase significantly based on your brand’s market conditions. Leadership needs to assess the brand before setting growth goals – or, set growth goals with a budget that is fair in supporting the sales efforts.

Now, let’s look at the value of that deal. We will use $30,000 as the number, even though the broker community has driven franchisors to increase their fees (which, in turn, are the franchisee's responsibility, now – a whole other story).

If the AUV is $1m annually and the royalty is five percent, then we can look at numbers around five deals:

1. Five Deals: $30,000 x 5 = $150,000
2. Five Deals that hit AUV will be at $5m in gross revenue to the franchisees and $250,000 to the franchisor
3. If those five deals remain in the system for five years (even though it should be 10) and average the AUV over that time, then the number turns into $25m x 5 Percent Royalty which = $1,250,000
4. When going to sell, you should get futures on that royalty, too
5. Let’s say two of those buy another unit. That’s another $10m x 5 Percent = $500,000

So, do you really want to chase the fee?

What happens when you chase fees?

1. The sales team is pressured to do deals. When pressured to do deals, they will sell franchises versus develop franchisees.
2. When you sell franchises (even though we are talking a HUGE life decision), you will convince the wrong people to join your franchise.
3. When you get the wrong people to join your franchise, they won’t validate.
4. When they don’t validate, your costs go up.
5. Other franchisees become disgruntled.
6. Your staff becomes frustrated by these mean franchisees.
7. Your brand is another brand that didn’t hit its goals.

And so on.

So, here are my truths:

1. Franchise fees are meant to cover the costs of opening a franchise. If you are increasing these fees to just pay the broker, you better come up with a good story for why. Franchisees think they are paying for the franchise. Few are honest and say it’s for the broker “coaching” that took place (that certainly has value, we are simply talking transparency). Make your franchise fee scalable with the lifecycle of your brand. Don’t hike it up. Don’t allow it to be a hurdle in the development process.
2. Good franchisees are better than bad. Bad will cost you a crap load. Be smart about who you let into your system.
3. If you sold five franchises last year, don’t ask your sales team to sell 20 this year. It won’t work.
4. Give your sales team the right budgets. And, the right budgets will change – meaning, other pieces will play into the sales process.

Brands that are royalty focused are typically the ones you hear about selling for a ridiculous multiple. Why? Private equity is not made of dummies. Better brands sell for more.

Don’t build a fee-based business, build a brand. Great things will come to those who do.