Understanding the costs of investing in a franchise business is vital for new franchisees, and in fact was one of the most important aspects for our users as reported on the Franchise Industry Survey of 2013 when considering which franchises to invest in, which highlights the value of due diligence resources in this area.
What are franchisors initially charging and what costs can new franchisees expect to pay? How can franchisees view these costs in comparison to the business proceeds they will take home, thus helping them to decide which franchise investment is the most viable for their particular situation?
Consider the following areas when figuring initial investment costs:
- Products, Service Purchasing, which is often not considered by potential franchisees, may involve purchases that are part of the agreement package that are directly related to supporting the franchisor’s affiliate companies. These purchases may involve equipment or support services related to the daily operation of the business, for example, and may be one time purchases or involved ongoing fees. Such purchases or services may or may not be offered at competitive pricing rates based on typical market activity, which is why franchisees benefit from researching and posing any questions necessary to understand how such purchases may impact overall earning potential.
- Initial, Marketing, and Royalty Fees are the three most common fee categories of franchise agreements. Initial Fees can range from around $10,000 and exceed $100,000, with a typical range being $20,000 - $40,000. These fees are typically paid per unit at the start of a franchise agreement.
Marketing Fees and Royalty Fees, which can be set figure fees paid monthly or a percentage of income paid annually, from a fraction of 1% to 50% of revenue. Such costs may be considered ongoing maintenance fees that regularly establish the relationship between the franchisor and franchisee, including any marketing support offered by the franchisor.
All franchisees must weigh whether or not these costs, when compared with the overall annual revenue for the franchisee and earning potential over time and throughout the duration of the agreement, are reasonable. Franchisees looking for a franchise agreement that makes room for realistic business proceeds do well to research whether or not about 1/3 of profits prior to tax are shared with the franchisor, while 2/3 remain with the franchisee. This is a general framework that many franchises stick to and franchisees can use it to calculate the costs of investing in a franchise business model.