What is a Franchise Fee: Everything You Need to Know
A franchise fee is a payment that a franchisee must pay to a franchise owner in order to start a franchise. 3 min read
A franchise fee is a payment that a franchisee must pay to a franchise owner in order to start a franchise.
Franchise Fee Law and Legal Definition
To open a franchised business, a person must pay a franchise fee to the franchisor. Although the state and federal definitions of a franchise can be different, the Federal Trade Commission (FTC) has a rule in place that defines a franchise in the United States. A business is known as a franchise if it meets three main criteria:
- The franchisor maintains significant operating assistance or control over the business.
- The franchisor licenses its logo, trade name, trademarks, service marks, or other marks to the person franchising the business.
- The franchisee pays at least $500 to the franchise owner before starting the business or within six months of operation.
A franchisee, also called a subfranchisor, must pay the required franchise fee in exchange for the right to continue a business or enter into a new business under an agreement maintained by the franchise owner. After paying the required fee, the franchisee can legally use the mark owned by the franchisor, as well as any other sundry items needed to run the business. Some of these might include setup processes and initial training of employees. This fee can reimburse the franchise owner for the costs of these sundry items, along with providing support to establish additional franchised locations.
Before a franchisee can start operation of the business under the name of the franchisor, they must pay the franchise fee. After it has been paid, the two involved parties will typically enter into a legal contract or agreement, which outlines the responsibilities of each to the other.
However, a franchise fee doesn't guarantee that the franchisee will receive everything needed to start the business, nor does it provide the right to operate the business in any manner. The amount of the fee required is based on the business stature, not on industry or location.
What Is an Initial Franchise Fee?
When a franchise owner grants a franchise to an individual, the new franchisee must pay the initial franchise fee. This amount varies among companies.
That initial fee may cover:
- The business launch by the franchisee
- Site identification
- Any necessary special equipment
The franchisor should also recover some of their costs when receiving the initial franchise fee.
This one-time fee is required up front when you sign a contract to open or take over a franchised business. When a franchisee signs the agreement and pays the required franchise fee, they can then start using the business products and/or name, including any proprietary materials, such as the trademark, computer software, operating manuals, or trade name.
What Is an Ongoing Franchise Fee?
Some franchisors require that the franchisee pay an ongoing franchise fee, which is typically a percentage of the sales or gross revenue of the business. This amount will usually be paid to the franchisor after the value-added tax (VAT) is deducted.
An ongoing franchise fee doesn't have a specific formula. Instead, the amount splits the responsibilities between the franchisor and the franchisee. When the franchisor offers more to the franchisee, the fee will typically be higher. Some franchises don't require the payment of an ongoing fee, but the product being sold is typically marked up enough to cover the loss of this fee.
A franchisor can also increase fees due to inflation or startup costs, but any increase in fees should be clearly communicated to the franchisee before they sign the agreement. Franchisors may outline details in an agreement that allow for increases in fees based on services provided to the franchisee. When the initial franchise fee has been paid and your business is in operation, you will likely have to pay some type of ongoing fee to the owner of the franchise.
Franchisors charge three common types of fees to franchisees:
- Advertising fees, which are used to advertise and promote the business. This fee could be a set monthly amount or calculated based on the percentage of gross sales.
- Royalties, which are usually calculated as a percentage of the monthly or weekly gross sales. These fees could be paid weekly, quarterly, or monthly, and they could also include updates, ongoing support, and any other resources.
- Additional fees, which could include fees for renewal, transfer, or other actions
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