When you join a franchise, you (the franchisee) will be responsible for paying several types of franchise fees to the franchise owner (also known as the franchisor). While some will be one-time costs, an ongoing fee you’ll be responsible for is the franchise royalty fee.
As a franchisee, you will pay out franchise royalties, though how much your franchise royalty fee actually is will depend on your specific franchise. The amount you pay will generally depend on your gross revenue; however, other factors also play a role.
The franchise royalty fee is an important cost to consider as you look into buying a franchise, as it will directly impact how much money you make each month. In this guide, we’ll cover what a franchise royalty fee is, its purpose for both the franchisor and the franchisee, and how much you should expect to pay in franchise royalties.
What Is a Franchise Royalty Fee?
A franchise royalty fee is money paid to the franchisor by their franchisees. This fee is generally paid out monthly or quarterly and almost always represented as a percentage of a franchisee’s sales. The franchise royalty fee is used to compensate the franchisor for use of things such as trademarks, licenses, and other proprietary assets, which enable the franchisee to operate. Franchisors also use this fee to reinvest in their business operations.
While franchise royalties are an important cost to consider, it’s important to note their difference from the initial franchise fee (often referred to simply as the franchise fee). The franchise fee is a one-time, upfront investment, whereas the franchise royalty fees are an ongoing payment to the franchisor each month. Both royalty and franchise fees are important to consider when deciding whether you can afford to buy into a specific franchise.
How Do Franchise Royalties Work?
Franchise royalty fees are set up in different ways, but they are generally represented as a percentage of a franchisee’s gross sales. Gross sales don’t include adjustments for things such as taxes or discounts—the gross profit number is your raw revenue. Royalty fees are paid out to the franchisor often monthly or quarterly.
In a way, you can think of paying out a franchise royalty fee as a kind of membership to a broader organization, which is the franchisor itself. For this ongoing cost, the franchisee can continue to use the franchisor’s trademarks, business model, menus, and more to help them successfully run their business. These royalties are used in many different ways by the franchisor, which we’ll get to below.
Fixed vs. Variable
Many royalty fees are fixed, but, occasionally, some will be adjustable either up or down—known as variable franchise royalties. These changes generally depend on the amount of revenue a franchise is making. There is sometimes a minimum fee that franchisees must also pay, regardless of their gross revenue.
How Much Is a Franchise Royalty Fee?
Franchise royalty fees generally fall around 5% to 6% of gross sales but can go up to 10% depending on the franchise. It’s also possible you may pay far lower than that—even a fraction of a percent if you’re operating at a significant scale (though this won’t happen at the very beginning of setting up shop). Again, the actual franchise royalty fee depends on the franchisor and the revenue that you’re making. It can also change throughout the life of your franchise.
Occasionally, some companies will require a minimum payment. But it’s important for the franchisor to keep the royalty in a manageable place for the franchisee; if the royalty fee ends up being too much, it may reduce a franchisee’s net revenue to the point where the franchisee can no longer operate their business. That’s bad news for both the franchisor and the franchisee.
It’s important to note that the franchise royalty fee isn’t the only fee you’ll be regularly paying in some instances. Some franchisors require an ongoing fee for things such as marketing and advertising expenses. Some franchisors don’t require this, and rather bundle the marketing fee into the overall franchise royalty fee. You’ll have to check with each specific franchise you’re considering to fully understand how they structure their franchise fees.
Franchise Royalty Fee Examples
Here are some franchise royalty fee examples from popular franchises, so you can get a sense of where your potential franchise prospect falls on the spectrum. The final franchise royalty fee you’ll be obligated to pay will be laid out in the franchise disclosure document (FDD), which you’ll receive a minimum of two weeks before you sign any franchise agreement.
- Pillar to Post Home Inspectors: 7% of gross sales
- Great Clips: 6% of gross sales
- KFC: 5.5% of gross sales
- Taco Bell: 4% of gross sales plus 4% advertising fee
- Ace Hardware: No royalty fee
Why Are Franchise Royalty Fees Important?
Franchise royalty fees, which are a cornerstone of the franchise model, are a massively important piece of the franchise. However, they’re important for different reasons to both the franchisor and the franchisee.
For the Franchisor
There are certain specific reasons why the franchising company commands a royalty fee from their franchisees.
Payment for Licensing
For the franchisor, the franchise royalty fee represents the revenue they make from each individual franchisee. This is inherent to the model of franchising; because you’re using their infrastructure, trademarks, fixtures, supply chain, etc., franchisees pay a fee. This money is also used to grow the franchising company and support its network of franchisees.
Marketing and Advertising Compensation
Many franchises are advertised on a national level, and the franchise royalty fee (or, on occasion, a more specific marketing fee) covers this budget for marketing and advertising the company as a whole.
The franchise royalty fee enables the franchisor to reinvest in their company, making improvements in things such as training, infrastructure, fixtures, and more.
For the Franchisee
While no franchisee actually wants to pay a percentage of their gross sales, there are reasons that can help a franchisee come to terms with it.
Franchisees need help from the franchisor to run certain parts of their business, as mandated by the franchise agreement. The royalty fee pays for this support. This may include legal help, business plans and strategies, marketing and advertising, and more.
As the franchise’s brand becomes bigger and more well known, the hope is that the individual franchises will benefit and see a lift in their success, as well. The royalty fee from a franchisee pays for the expansion of the brand.
Do All Franchisees Pay Royalties?
Not every franchisee pays a specific franchise royalty fee. There are some other setups in which there is no direct fee, but rather parent companies set up other agreements to make money from the franchisee, such as making purchases directly from the franchisor, such as products to stock the shelves.
Keep in mind, though, it is much more likely that you will pay a traditional royalty fee to the franchisor, as this is the most common setup.
Is the Franchise Royalty Fee Worth It?
Is the fee that you’ll pay worth it if cuts into a margin of your gross sales? It’s a tough question to answer, and will depend on the franchise you’re looking to open as well as how well you run your business.
Of course, if you opened and ran your own business from scratch, you wouldn’t have to pay a royalty fee—which everyone would naturally prefer. But, one of the main advantages of franchising boils down to wanting the infrastructure that a franchise model can provide. And that comes at a cost.
One way to figure out if the franchise royalty fee is worth it is to first see what your specific royalty fee would be as required by the franchisor and then do some projections to see how much you would be paying based on estimated revenue and measure it against the costs that you anticipate will be involved in running your business. Calculate estimates for both conservative and best-case scenarios.
You might also consider reaching out to other franchisees to get their take—you can learn about the franchise royalty fee as well as other important details on how they feel about operating that specific franchise.
The Bottom Line
You should expect to pay a franchise royalty fee monthly or quarterly, which is generally determined by your gross sales. In some cases, the franchise into which you’re looking will not require a franchise fee, but you should expect that the company gets compensated through other means. At times, there is a minimum required payment, which is due even if your gross sales are low.
The franchise royalty fee is one of the most important parts of the franchise model. If it’s something you’re not comfortable with, you might want to consider looking into a different type of business. But before you decide either way, continue to dive deep into the overall franchise mode, which includes the franchise royalty fee. The first step to understanding this part of the franchise model is to do your homework about the company and find out their fees.
And if cost is an issue but you’d prefer the franchise model than starting your own business from scratch, consider these low-cost franchise options to help you save in other ways.
Christine Aebischer is an editor at JustBusiness and Fundera.
Previously, Christine was an editor at the financial planning startup LearnVest and its parent company, Northwestern Mutual. There she wrote and edited on topics such as debt, budgeting, insurance, taxes, investing, and retirement. She has written for print and online on topics ranging from personal finance to luxury real estate.