Owning a franchise lays a blueprint for success. It’s like buying a house that’s not just built but is also fully furnished and functional. However, just like any house comes with maintenance costs, a franchise also comes with various costs. Now, if this made you wonder: What are the costs associated with operating a franchise? Then, you have landed on the right page.
To be honest, a franchise comes with a plethora of benefits in a box, like a recognized brand and established business model, but it also has cons that might make you take a step back.
Therefore, understanding all these costs that are required to start a franchise is crucial. So, without delay, let’s start our guide of understanding each and every cost that is essential to start a franchise.
What Is Franchising?
Franchising is essentially a contractual agreement, a license, that allows the owner of a business to grant the use of the brand’s name, its trademark, processes, strategy and the propriety business knowledge to the franchisee.
Franchising work in similar ways most of the time since it is a contractual agreement that works on certain guidelines and rules.
To start the franchising cooperation, a franchise business owner partners up with a franchisee.
The franchisor grants the rights of the brand and intellectual property through a contractual agreement on an agreed initial fee.
Once the agreed fee is paid and both sides agree on the agreement, the franchisee can start to set up the branch.
Benefits For Franchisees
If you are thinking of owning a franchise, then you must remember that a franchise comes with a plethora of benefits. It comes with a recognized brand name, an established customer base, consistent advertising, and a well-strategized business model.
Most often, the franchisors also help you with all the necessary training and support required to run the franchise smoothly. So, if you are new in the industry without any knowledge, then owning a franchise is the ideal option for you.
Benefits For Franchisor
There are a lot of benefits for the franchisor when franchising its business. Firstly, the franchisor gets to expand its business to new locations. Franchisors are also sharing their ideas, expertise and assistance for which they get paid.
The payment typically includes a lump sum franchise fee, a certain percentage of the gross sales, and other costs such as royalty fees, advertising, and licensing fees.
For example, Dunkin’ Donuts charges an initial franchise fee of $40,000–$90,000 for traditional franchises and also charges 5.9% as royalty fees.
What Are The Costs Associated With Operating A Franchise?
1. Franchise Fee
The very first cost associated with opening a franchise is the franchise fee. The franchise comes with a lot of support and brand recognition, so you are required to pay to be associated with the brand.
So, basically, you are renting out the brand and paying for using it. Typically, the amount of franchise fee can be as little as $8000 to more than $1,000,000.
The franchise fee can vary greatly depending on the popularity and scale of the franchise. Moreover, it is a one time upfront fees that give you the license to operate under the franchise name.
2. Accounting Fees
Before signing the contract, it is recommended to consult with an attorney who is familiar with the franchise law. The attorney will help you to review the franchise disclosure document and will also help you to review other necessary documents.
Each attorney will charge you differently, and the fees depend on the amount of time the attorney will take to review the documents. It’s also recommended to tie in with an accounting firm as soon as you decide to buy the franchise.
An accounting firm will help you set up the books and records for the company and can also help you determine the required working capital.
3. Real Estate Cost
Whether it’s a fast-food drive-thru chain or a retail store, location plays a crucial role in the success of most franchises.
The real estate costs include lease payments and utility hook-ups. Some franchises also have specific guidelines on the selection of the location. Therefore, you might need to spend extra to abide by those guidelines.
4. Royalty Fees
Another essential cost associated with operating a franchise is the royalty fees. Unlike franchise fees, which are a one-time payment, royalty fees are ongoing payments.
These fees are typically a certain percentage paid out of your gross sales or revenue. The royalty payments can range from as low as 4% to as high as 12%. You can expect to make payments on a monthly or quarterly basis.
Royalty fees enable the franchisor to continue supporting your business through training, marketing, and product development services. You must remember that royalty fees are calculated differently by every franchise. So you must understand what you’ll be responsible for and what you’ll receive.
5. Advertising Fees
You might have seen the franchisor’s commercials on social media, the internet, billboards, and even on a paper mail campaign. All this requires some capital; therefore, many franchisors expect the franchisees to pay the advertising fees.
This advertising fee is charged just like royalty fees. With the help of advertising fees, the franchisors are able to create and run advertising campaigns, which in turn help the franchisee to increase the recognition of the grand.
Advertising fees are an integral part of the cost of the franchise as they build brand recognition and attract new customers to the entire franchise system.
6. Training And Support Fees
When you enter the world of franchising, most often, the franchisor provides the necessary training and support to the franchisee. Therefore, some franchisors charge for the training and support provides along with the initial investment.
If your franchisor doesn’t charge for the training and support fees, then it is probably included in the initial investment.
Moreover, before moving forward with signing the agreement, you must understand what type of training and support you’ll be receiving and what it will cost.
7. Equipment and Inventory Fees
The next fees you should consider are the cost of equipment, inventory, and technology. Depending on the industry and franchise, you might have to purchase specific equipment, inventory, and technology from the franchisor or their approved supplier.
This includes everything from point-of-sales systems to uniforms to food products. It’s quite difficult to estimate the cost required for equipment and technology as it varies on the industry and the franchisor’s requirements.
However, be sure about all the equipment, inventory, and technology required to run the franchise before you sign the agreement.
8. Franchise Renewal And Transfer Costs
You, as a franchisee, might also encounter a situation where you want to transfer or renew your franchise business. In this case, the franchisee can negotiate the terms of the franchise agreement.
When transferring the franchise business to a new franchisee, the franchisor generally charges a franchise fee that ranges between 25 to 50% of the initial franchise fee. In additional the legal cost is also paid to the franchise lawyer, which ranges from $500 to $1,000 or more.
What Are The Financing Options For Franchisees?
Now that you have a clear understanding of all the costs associated with opening the franchise let’s look at the various financing options available to fund your franchise.
1. Small Business Administration (SBA) Loans
This is a loan program under which the US Small Business Administration helps small businesses get funding by setting some guidelines for loans and reducing lending risk.
This loan program is specifically designed for franchisees. The loans can provide the necessary capital to start or even expand the franchise at some favorable conditions.
2. Loans From Banks
Bank loans are the second option many franchisees can select for funding. Many banks and financial institutions offer loans tailored for small businesses.
However, to obtain loans from banking institutions, you may require some collateral or personal guarantee. Sometimes, they also require a solid business plan and financial projections.
3. Personal Savings
The third option is to use your personal savings or retirement funds to fund your franchise business. This eliminates the issue of collateral and also saves you from going into debt.
Therefore, this option eliminates the need for external financing but, at the same time, carries personal financial risks.
How To Calculate The Total Investment Required For A Franchise?
When determining the total investment required to operate the franchise, first ensure that you understand all the costs mentioned above.
To calculate the total investment, you’ll need to add up the franchise fee, additional costs, and working capital. Now, working capital is the cost that is required to cover the day-to-day expenses of the business until it becomes profitable.
Therefore, it’s important to have enough working capital to sustain the initial months or even years when the revenue is low.
However, to accurately calculate the initial investment or total investment, we recommend consulting a financial advisor or an accountant who has experience working in the franchise industry.
There’s no doubt that owning a franchise is a better option than starting a business from scratch. However, a franchise is no easier than a business. It has its own legal terms and requirements that need to be understood by the franchisee.
The very first question that franchisees should ask is: What Are The Costs Associated With Operating A Franchise?
This is simply because there are many costs associated with opening the franchise. And each and every cost should be thoroughly checked either by the trusted franchise attorney or the franchisee.
Do I need to pay franchise fee every year?
No, the franchise fee is the amount you ay at the time of signing the agreement. It is a one-time payment that gives you the license to use the franchise brand.
How much does a franchise owner makes?
The salary of the franchise owners differs from industry to industry as well as by location. For example, a franchise owner in Illinois earns $120,751 annually, and a franchise owner in California earns $117,564 annually.
How long does a franchise agreement lasts?
The typical length of a franchise agreement is between 5 to 20 years.