What are Franchise Royalty Fees?

What are franchise royalty fees, are they negotiable and are they tax deductible?

Franchise Royalty Fees Explained

What Are Franchise Royalty Fees?

Franchising is a great way to get in to business ownership for yourself, but not by yourself. By going down the franchising route, you’re minimising many of the risks you would otherwise be exposed to had you gone it alone. Franchises have a great success rate, with the bfa reporting over 90% of franchisees profitable, and with the franchising sector worth a whopping £17bn to the UK economy, it’s a fantastic industry to be a part of.

However as with any business venture, franchising isn’t without costs. There are several types of costs associated with buying a franchise, one of which are franchise royalty fees. Let’s learn more.

What are the Costs Associated with Buying a Franchise? Ongoing Fees and Initial Fees Explained.

Most franchise payments will fall into either initial fees or ongoing fees, and royalty fees are considered ongoing fees. It’s important to understand both. Usually the main initial fee for a franchise secures the use of the company’s trademarks, enabling you to trade under the franchisor’s brand. This will often cover your training and support, plus the franchise package including equipment and stock. This might be called initial investment, initial fee or franchise investment. On average franchise initial investment is in the region of £40,000 however some franchises can be invested in for less than 10k.

In terms of ongoing fees, the main fee is the royalty fee. Royalty fee is also known as a management service fee (MSF), or variations of that such as monthly service fee, or just service fee. You may also pay a marketing fee ongoing, or this might form part of the franchise royalty fees. In other contexts, royalty fees refer to continued usage of a license, and this is the same in franchising. By paying a royalty fee or service fee, you’re paying for the continued access to the brand and intellectual property.

Are Franchise Fees Tax Deductible?

The initial franchise fees are not tax deductible because they are considered capital expenditure however royalty fees are tax deductible in most cases because they are business expenses.

Because upfront initial investment covers intangible assets like the license, branding and trademarks, they are not tax deductable. Royalty fees are considered business revenue expenses so are tax deductable.

You will need to speak with the franchisor about tax classifications on the different elements within the franchise business as some may be subject to tax deductions and others not.

Can a Franchise Royalty Fee Change?

There are two ways that royalty fees are worked out by the franchisor, and it is important to know which before you invest. The two types of royalty fees are fixed royalty fees and sales-based royalty fees. A fixed fee is where the franchisor sets a fixed amount regardless of how much your business earns. A sales based fee is variable and calculated on a percentage.

  • Fixed Percentage Royalty Fees – Based on your sales, fixed percentage fees will take a certain percentage each month.
  • Increasing Percentage Royalty Fees – The franchisor may increase the percentage depending on turnover or location.
  • Decreasing Percentage Royalty Fees – The franchisor may choose to decrease royalty fees or suspend them completely either at the start of the franchise agreement, or decrease fees as turnover increases.

With percentage based royalty fees, the franchisor may impose a minimum fee to ensure that targets are achieved by the franchisee.

What Do Royalty Fees Cover?

Franchise fees are more than just profit for the franchisor. They are often used for a number of purposes such as:

  • Marketing and Franchise Network Promotion – Many franchises carry out national marketing campaigns such as TV ads to drive more bookings for franchisees, and help brand awareness
  • Fund Franchise Research & Development – So franchise networks can keep up with market and demand trends, franchisors will invest into R&D to keep up with what people are interested in.
  • Further Growth of the Franchise – Franchise advertising isn’t cheap and royalty fees will be used by the franchisor to fund further growth and build the network.

Are Franchise Fees Negotiable?

In most cases royalty fees are not negotiable. They are enforced to promote fairness and equality across the brand. However if you achieve a greater turnover your franchisor may consider decreasing percentage franchise royalty fees as a gesture of goodwill. Some may not like the idea of percentage based turnover and the case of the more you earn, the more the franchisor earns but at the end of the day your success is the franchise network’s success anyway.

Conclusion

You should find out as much as you can about the royalty fees before investing in a franchise. Ultimately it is the fixed royalty fees that can catch people out, especially those looking to invest in a part time franchise. Fixed fees combined with minimal working can mean the franchisee will be earning very little so where fixed fees come into play it is always a good idea to earn as much as possible. Percentage based fees will vary depending on how much work the franchisee applies, and it is important to remember that the franchisor may have the safety-net of a minimum fee in the case of royalty fee payments. Speak to the franchisor to learn more about what fees are charged, what type of fee they are and whether the franchise fees are negotiable.

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