Tutorial 5: Intro to Royalties

Within almost all franchise systems, franchisees are required to pay a royalty fee. This is an ongoing payment that gives franchisees the right to use the franchisor’s trademarks and operating system.

Why pay a royalty fee?

Customers tend to trust brands they know. It’s one of the reasons why the franchise business model remains so popular!

For the franchisee, paying royalties means access to a proven brand and business model – one that customers tend to be more receptive to.

For the franchisor, royalty fees help them create an infrastructure that provides ongoing support to franchisees, including:

  • Consulting and sharing of best practices
  • Arranging suppliers to capitalize on purchasing power
  • Research and development
  • Operational reviews and ensuring brand consistency
  • Accounting systems
  • Computerization
  • Field support
  • Initial training programs
  • Ongoing training programs

How much do I pay in royalty fees?

There is no standard royalty fee payment – business models vary. However, there are two common ways fees are structured:

  • Gross Sales

This is a payment by which a franchisor charges a percentage of a franchisees’ monthly or yearly gross sales. Since there is no standard amount, it can range from three percent to 10 percent and more. Within that there are three different ways this can be calculated:

  • Fixed percentage – Franchisees pay the same percentage of gross sales on a monthly or quarterly basis.
  • Increasing percentage – The percentage that a franchisee pays varies on a monthly, quarterly or annual basis. This tends to provide motivation for franchisors to help their franchisees increase their sales.
  • Declining percentage – Some franchisors use this system to reward profitable franchisees. If the franchisee is selling more, they might lower royalty fees as a result.

 

  • Flat-fee Rate

There is no guesswork with this type of payment. Franchisees pay the same amount (not calculated by percentage) regardless of gross sales. While this system might seem attractive because franchisees know exactly what the expected costs are every month, it can be disadvantageous for franchisees who must pay the same fee during down periods. It also doesn’t provide franchisors added incentive to help their franchisees increase their sales.

How do I know if I’m paying the right amount?

Low royalty fees, while exciting at first, are not always advantageous for franchisees. It can mean an inability to provide franchisees with the level of support needed for success.

Still, before becoming a franchisee you should do your due diligence. Speaking with current and past franchisees is undoubtedly a great start.

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Disclaimer
The opinions or viewpoints expressed herein do not necessarily reflect those of the Canadian Franchise Association (CFA). Where materials and content were prepared by persons and/or entities other than the CFA, the said other persons and/or entities are solely responsible for their content. The information provided herein is intended only as general information that may or may not reflect the most current developments. The mention of particular companies or individuals does not represent an endorsement by the CFA. Information on legal matters should not be construed as legal advice. Although professionals may prepare these materials or be quoted in them, this information should not be used as a substitute for professional services. If legal or other professional advice is required, the services of a professional should be sought.