Understanding Franchise Royalties: How Much Will You Pay?

Purchasing a franchise is a great way to step into entrepreneurship without taking the immense risks associated with other types of businesses. But in order to capitalize on an established brand, you’ll have to pay royalties to the franchise. If you are a bit lost when it comes to franchise royalties, don’t worry. You aren’t alone.

In this article, I will break down exactly what franchise royalties are and how much you can expect to pay.

Key Takeaways

• Franchise royalties are ongoing fees that franchisees pay to franchisors for continued use of the brand, systems, and support.
• Most royalties are calculated as a percentage of the franchise’s gross sales, typically ranging from 4% to 12%, though some franchisors charge a fixed fee.
• These fees fund ongoing support services from the franchisor, including marketing, training, and system enhancements.
• Royalty fees vary by industry and franchise agreement, making it essential for franchisees to understand the fee structure before committing.
• Understanding franchise royalties is crucial for evaluating the total investment and ongoing costs of owning a franchise.

What Are Franchise Royalties?

When you purchase a franchise, you’ll pay an initial payment to the franchisor, called a franchise fee, that gives you the right to operate the established business. However, the fees don’t stop there. Franchise royalties are an ongoing cost that franchisees pay to the franchisor for the continued use of the brand, products, and services. This is how the franchisor profits from allowing franchisees to operate their business.

Most franchise royalties are calculated as a percentage of the franchise’s gross sales, though some franchisors charge a fixed royalty fee. Royalties are a defining feature of the franchise system, allowing franchisees to access the proven business model and receive continued support from the franchisor.

How Much Are Franchise Royalties?

Franchise royalty fees vary from brand to brand, but you can generally expect to pay somewhere between 4% and 9% of your gross sales. However, some brands may charge up to 20% or more. It is an important distinction that franchise royalties are based on gross sales and not profit.

For example, if your franchise makes $100,000 in revenue and the parent company charges a 5% royalty fee, you’ll pay $5,000 to the franchisor.

Here are some of the franchise royalty fees for well-known brands:

• Dunkin Donuts: One of the most successful franchise brands charges a royalty fee of 5.9% and an initial franchise fee of $40,000.
• Subway: If you want to open your own Subway store, you need to be prepared to pay franchise royalties of 8% per week based on your gross sales. To buy into Subway, you’ll also pay a $15,000 franchise fee.
• McDonald’s: Franchisees at McDonald’s pay around 4% to 5% in royalties. McDonald’s has fairly specific requirements for new franchise owners. You’ll need to pay a $45,000 initial franchise fee and have at least $500,000 of available non-borrowed liquid assets to qualify.
• Supercuts: To run a Supercuts franchise, you’ll need to pay 4% in franchise royalties for the first year, increasing to 6% in subsequent years. Supercuts charges a $39,500 initial franchise fee.

The Role of Royalty Fees in Franchise Systems

As a franchisee, you benefit from the brand recognition of your parent company, but like just about everything in life, this doesn’t come for free. This is where your royalty fee fits into the franchise system. You’ll typically pay your royalties each month according to your franchise agreement.

Franchise royalties vary depending on the type of franchise business. For example, restaurant franchises, which tend to be high-volume businesses, typically have lower royalty percentages than other industries.

On the other hand, if you purchase a tax preparation franchise, the royalty percentage will generally be set MUCH higher. For example, H&R Block charges a franchise royalty fee of between 20% and 60%.

This may sound extraordinarily high, but since tax preparation businesses have far fewer ongoing expenses than restaurant franchises, the burden of the royalties on your overall profit is less.

No business owner is going to like the idea of continually paying franchise royalties, but the fact of the matter is that both parties benefit from this system. As long as the royalty fees are fair, they are a small price to pay for gaining access to a trusted brand and receiving ongoing support from the franchisor.

Difference Between a Royalty Fee and a Franchise Fee

One area of confusion for potential franchise owners is the difference between royalty fees and franchise fees, which are two distinctly different costs. While a royalty fee is an ongoing cost based on your gross revenue, the franchise fee is the cost of entry. 

Essentially, the franchise fee is an upfront cost to unlock the franchisor’s proprietary business system. This fee provides you with a license to own and operate your new franchise business. The franchise fee also typically includes some of the costs to set up your franchise, train staff, and initial marketing campaigns.

Royalty fees are how franchisors make a profit and sustain the franchise system over time. These recurring payments help fund ongoing support, brand development, and national advertising efforts. Royalty fees also help the franchise network stay competitive and consistent across all locations.

How Do Franchise Royalty Fees Affect Profitability?

Since your franchise royalty fees are based on your revenue, not your net profit, there is massive potential to impact the profitability of your franchise. This makes balancing your expenses a bit more challenging than with a standard business. Franchise royalties can have a varying effect on your business’s profitability depending on the number of expenditures your franchise has.

For example, let’s take two different franchises with a 5% royalty fee and $1,000,000 in revenue each year. But, one business has $100,000 of expenses, the other has $250,000 of expenses.

Both businesses would need to pay $50,000 for their franchise royalty fees, but the royalty fee for the second business would have a far greater impact on profitability. The net profit of the second franchise would be $700,000 compared to the first franchise’s $850,000.

Fixed vs. Variable Royalty Fees: Which Is Better?

There are two main types of franchise royalty fees: fixed rates and variable rates. As the name suggests, fixed royalty fees are a set amount that you pay regardless of your profits or sales. For example, if you have a fixed royalty fee of 4%, you’ll pay $4,000 for every $100,000 you sell. The advantage of fixed royalty fees is that they are easier to budget, as you’ll know how much you’ll pay each month. But, if your sales are low or your costs are higher, this may impact profitability. 

On the other hand, variable royalty rates are based on your franchise’s performance. In some cases, you will pay more when your sales are higher, but if you sell less, you’ll pay less. But in other cases, the opposite is true to encourage better performance. While variable royalty fees can help with your cash flow, they can also make the costs unpredictable.

Factors That Affect the Cost of a Franchise Royalty Fee

When you’re considering franchises, you’re likely to discover that the royalty fees can vary significantly. This is due to a number of different factors. 

Brand

Brand recognition has a massive influence on the cost of franchise royalty fees. There are some brands that instantly resonate with potential customers and, therefore, provide your enterprise with a greater sense of legitimacy.

A great example of this is Chick-fil-A. This brand is instantly recognizable, and customers are aware that if they head into a restaurant, they can expect the same quality products as they would get on the other side of the country. Interestingly, Chick-fil-A only charges a $10,000 initial franchise fee, but you’ll need to pay a whopping 15% in royalties as well as 50% of all profits!

Franchisor Support

If you’ve ever started a new business, you’ll be aware that the early days can be challenging, but when you purchase a franchise, you’ll receive a lot of support from the parent company. The level of support you get is heavily dependent on your royalties and the cost of the franchise fee. While not always the case, franchises with higher royalties tend to offer more support than those with lower ongoing fees.

While it may be tempting to overlook a franchise with higher fees, it is important to assess the level of support offered. It may be worth paying slightly higher costs if you have the assurance that the parent company is prepared to help you succeed.

Market Conditions

The market also plays a crucial role in franchise fees. If demand for a franchise’s products or services is low, it is unreasonable to expect franchisees to pay higher costs. As with the earlier example, McDonald’s tends to have consistent demand, so it can charge higher franchise fees and consistent royalties. On the other hand, if a franchise is more speculative, the demand may significantly fluctuate, and potential franchisees may be unwilling to commit to higher royalties.

Profit Margins

Generally speaking, the higher the profit margins, the higher the franchise royalty fees. Although there are some exceptions, most franchise industries with high profit margins, such as accounting and legal services, come with higher royalties than other industries.

Sales Volume

This factor isn’t actually controlled by the franchisor since the sales volume comes down to your efforts in setting up and running the franchise. However, since royalty fees tend are based on a percentage of your gross sales, the more sales you make, the more you will pay to the franchisor.

Franchise Royalties: A Small Price to Pay for a Proven Business Model

Franchise royalties are an inevitable part of joining a franchise. Royalties are an ongoing cost that allows you to unlock the tools and brand recognition you’ll need for your franchise to succeed. 

Ready to explore your options? Franzy is your one-stop shop for researching and connecting with over 2,000 franchises, empowering you to make data-driven decisions and find the perfect fit for your entrepreneurial journey.