As you consider becoming a franchisee, be aware of the franchise hidden costs beyond the initial fee. Franchise fees are just one piece of the puzzle. Ongoing royalties, marketing contributions, equipment leases, and inventory purchases can add up quickly. Weigh the pros and cons of owning a franchise to make an informed decision. Buying a franchise may still make good business sense, but go in with eyes wide open about the true costs. Before we get deep in the brass tacks, let's take a step back and understand what exactly makes a franchise.
What Is a Franchise?
A franchise is a business whereby an owner (franchisor) licenses its trademarks and methods to individual investors (franchisees) who operate each franchise location. The franchisee pays initial franchise fees and ongoing royalties to the franchisor. In return, the franchisee gets to use the franchisor's established brand name and business model. The National Franchise Association estimates there are over 733,000 franchise businesses in the U.S. employing millions of people and generating billions of dollars in economic output.
While buying into an established brand seems appealing, there are many franchise hidden costs. First, there is the initial franchise fee, typically ranging from $20,000 to $50,000 per location. Then there are ongoing royalties, usually 5-10% of revenue. There are also renewal franchise fees every few years.
Additional Fees
Franchisees must pay for business licenses, permits, insurance, training, travel, grand opening marketing, and the actual business space. Franchisees are also typically required to buy supplies, equipment, and inventory from approved vendors at premium prices.
Restrictions and Loss of Control
With a franchise comes many rules and restrictions on operations to maintain brand consistency. However, this limits a franchisee's control and flexibility. The franchisor controls details like business hours, employee uniforms, interior design, and menu or product offerings. Franchisees have limited say in major business decisions yet shoulder much of the financial risk.
Upfront Costs of Purchasing a Franchise
Initial Franchise Fee
When you purchase a franchise, the initial franchise fee is typically the largest upfront cost. This fee can range from $10,000 to over $500,000 depending on the franchise. The initial franchise fee provides you the rights to use the company's trade name and operating procedures. Some franchisors charge a flat franchise fee while others base it on a percentage of estimated sales. Make sure you understand how the franchisor calculates the initial franchise fee before purchasing a franchise.
Training Expenses
Most franchisors require new franchisees and key staff to complete an initial training program to learn critical operations and procedures. The training usually takes place at the franchisor's headquarters and can last weeks or months. You will need to pay for travel, lodging, and living expenses during the training for yourself and any staff. These additional franchise unexpected expenses are often not mentioned in the franchisor's literature but can amount to thousands of dollars.
Additional Start-Up Costs
Beyond the initial franchise fee and training expenses, you will face many other franchise unexpected expenses to get your startup up and running. These include securing business licenses and permits, purchasing equipment and inventory, leasing commercial space, building out the space, hiring and training staff, and marketing expenses to generate awareness about your new business. Make sure you develop a comprehensive business plan that realistically estimates all your start-up costs so you go into your new franchise with your eyes open.
Owning a franchise can be very rewarding but also quite expensive. Do thorough research on the total investment required and make sure you understand all the potential franchise hidden costs before deciding if ownership is right for you. With proper planning and realistic expectations about the total costs, you will be in a much better position to make an informed choice.
Ongoing Franchise Fees You Pay to the Parent Company
When you sign on to become a franchisee, you pay an initial franchise fee, typically ranging from $10,000 to $50,000 or more, to the franchisor for the rights to use their brand and business model. However, the franchise fees do not stop there. As a franchisee, you must pay ongoing royalties and other fees to the franchisor to continue operating under their name.
Royalty Fees
Royalty fees, also known as royalties, are ongoing payments, usually a percentage of your gross sales, paid to the franchisor for the right to continue using their trade name and operating procedures. Royalties typically range from 4 to 12 percent of gross sales and must be paid whether your franchise turns a profit or not. The specific royalty fee depends on the brand and industry. The National Franchise Association provides resources to research the fees of different franchises.
Advertising Fees
Most franchisors require franchisees to pay into an advertising fund, typically a percentage of gross sales, to promote the brand on a national scale. As a franchisee, these mandatory fees mean you must help pay for things like TV commercials, social media marketing, and promotional events and materials distributed on a national level, even if you do your own local marketing as well. Advertising franchise fees usually range from 1 to 2 percent of gross sales.
Renewal Fees
Franchise agreements are not indefinite. They typically last 10 to 20 years before needing to be renewed. When it comes time to renew your franchise agreement, there is often a renewal fee, which can cost as much as half of the initial franchise fee. The renewal process also usually requires upgrades to your location and systems to match the latest brand standards.
While the ongoing expenses of royalties, advertising, and renewal fees are often outlined in the Franchise Disclosure Document, the total cost over the lifetime of a franchise can easily amount to hundreds of thousands of dollars. As with any business investment, make sure you understand all the potential franchise fees and expenses before signing an agreement. With adequate planning and budgeting, these franchise hidden costs should not come as a surprise.
Conclusion
The upfront franchise unexpected expenses of ownership are just the start. Ongoing fees, marketing expenses, and more can really add up. Be sure to thoroughly investigate the National Franchise Association's resources to make an informed decision on the pros and cons of owning a franchise for your situation. Evaluating the franchise hidden costs upfront and creating realistic financial projections will set you on the path to success if you decide franchising is right for you.
