The majority of the franchises will charge royalties, which can be collected on a monthly or weekly bases.
The franchise royalties are expressed as a percentage of the gross revenue of the business during the period applicable. Sometimes, royalties can be charged as a fixed amount that won’t vary with volume (for example, a flat fee of U$100/week).
Some franchises don’t charge any royalties, and when this is the case, the way they will monetize is many times through agreements with suppliers that will offer products to the franchisees, as well as through conferences they organize where suppliers pay a sponsorship fee to be present and be able to market to the franchisee network.
Most franchises charge around 4-6% royalties, but there is quite a lot of variation and it tends to depend on the business model and industry it belongs to. Some franchises, specially linked to services, might charge higher royalties percentages, but also tend to have higher margins overall.
Some franchisors also provide a declining royalties incentive program in which the royalties are charged at a higher percentage up to a certain gross revenue threshold, and as the franchisee surpasses that value, the royalty % declines. For example, franchisees might pay initially 5% royalties up to the first U$200,000 gross revenue generated, and will then pay 4% on the incremental gross revenue.
Why do franchises charge royalties?
In addition to enabling the franchisor to profit, royalties typically will cover the costs of operations and many services provided by the franchisor to the franchisees in their network, such as ongoing support and training, new developments, and others. Without this fee, the franchise company would probably go out of business and not be able to support the brand and its operations, which could hurt all franchisees.
How to evaluate if the royalties charged by a franchise are reasonable?
The most important way to evaluate if the royalties and other franchise fees are reasonable is though building a business plan and financial projection, that allows you to see how much you have the potential to net (net profit) after all fees and other expenses are paid. As long as the number is good and in line with your expectations, it should be okay to invest in the franchise.
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