Understanding Royalties and Fees in Franchise Agreements

Franchising offers brand recognition and a support system for entrepreneurs, in exchange for a few fees. Here are the details on the typical costs associated with franchising.

By Erica InmanStaff Writer

8:08AM • 06/29/24

Franchising offers entrepreneurs an established business model and name recognition. However, these factors come at a cost. Franchising requires business owners to pay royalties and fees as part of their investment, as detailed in the franchise agreement.

1851 Franchise spoke with Jack Mashini, co-founder of Wing Snob, to learn more about what you, as a franchisee, are paying for.

Franchise Fees

The franchise fee is paid to the franchisor at the very start of a franchise investment journey. Essentially, the franchise fee serves as a ticket to entry, granting individuals the rights to leverage the franchisor's business model and brand.

This fee typically ranges from $20,000 to $50,000, but can be less or far more depending on the brand. The franchise fee reflects the value of accessing the franchisor's established infrastructure and intellectual property. According to Mashini, this fee, along with others, is worth the expense.

“They are giving you all their trade secrets that have worked numerous times over,” he said. “[Franchisees] benefit from expanded brand awareness, bulk buying discounts that a single unit would not benefit from and a larger marketing budget to roll out meaningful campaigns to get the word out about their new business.”

Royalty Fees

Once franchisees have paid their initial entry into the franchisor's world, they will be obligated to pay ongoing royalty fees. These payments are a recurrent percentage of the franchisee's revenue and compensate the franchisor for continued brand usage and operational support. Royalties typically range from 4% to 12% of gross sales.

Royalties can be seen as representatives of the mutually beneficial relationship between a franchisee and franchisor. The ongoing payment showcases the interest both parties have in driving business growth and profitability going forward.

Other Required Fees in Franchising

Franchise concepts will vary in their requirements of additional fees, but some typical fees a franchisee can expect to pay include:

Professional Fees. Prospective franchisees may wish to seek legal and accounting assistance to review the legal documents such as the franchise disclosure document (FDD) and franchise agreement.

Advertising and Marketing. Franchisees and franchisors often both contribute funds towards advertising and marketing.

Operating Capital. Franchisees should consider the additional funds required to cover daily operating costs for at least three to six months before the business becomes profitable.

Supplies and Equipment. Depending on the brand or industry, there may be costs associated with inventory, point-of-sale hardware and other essential equipment.

Insurance. The insurance required will vary depending on the type of business, but may include workers' compensation, property and casualty insurance, and auto insurance.

Building, Construction or Real Estate: For brick-and-mortar concepts, franchisees can expect expenses for land purchase, building permits, construction, furniture, fixtures or other real estate needs.

Franchise Agreements

All of the royalties and fees required of a franchisee will be spelled out in the franchise agreement — a comprehensive, legally binding document that details the rights and obligations of both franchisor and franchisee.

The FDD is another important document that provides a prospective franchisee with transparent information about the franchise’s financial performance and legal obligations.

“It's very important to review the FDD from any brands you may have interest in,” Mashini said. “Specifically Item 7 and Item 19 within the document because those items will discuss costs to get rolling and average expected results from a financial perspective.”

A thorough review of the FDD before signing a franchise agreement empowers franchisees to make informed decisions before making a commitment.

Estimating Total Franchise Costs

A slew of factors influence franchise costs, including the choice of franchise brand, industry segment and geographical location. Thorough examination of the FDD, particularly sections detailing initial fees and estimated investments, can help franchisees get a clear idea of the cost of entry and operational requirements. Prospective franchisees should also be sure to speak to existing owners with the brand to get a better understanding of the costs required to operate a franchise. And if the costs feel overwhelming, just know there are financing options available.

“There are many SBA programs available that make funding much more attainable than the typical bank route,” Mashini said.

To learn more about the costs involved in franchising, check out these resources:

*This brand is a paid partner of 1851 Franchise. For more information on paid partnerships please click here.