As point of departure, we need to remember that franchising is a business tool developed by entrepreneurs for entrepreneurs. To be sustainable in the long term, the concept must offer franchisors and their franchisees realistic opportunities to make more money than they would make if left to their own devices. Over the past five decades, franchising has proven sufficiently robust to make this possible, provided that this is approached correctly.
- Sources of income for the franchisor
It is customary for franchisors to charge an upfront fee or initial fee and ongoing fees.
- Upfront fee
In terms of good franchise practice, the upfront fee should help the franchisor to recover over time the costs incurred in setting up the franchise. It should also pay for the expense of training the new franchisee and helping him/her to set up the business. Lastly, the upfront fee compensates the franchisor to some extent for the development of the brand and intellectual property associated with the franchise.
Upfront fee amounts range from R25 000 to R150 000 and more. This depends on the complexity of the business because it is influenced by training costs. The standing of the brand comes into play as well. When projecting capital requirements, prospective franchisees need to remember that in addition to paying the upfront fee, they need to raise funding for the establishment of the business and working capital.
- Management services fee
The management services fee (MSF) pays for the right of access to the franchisor’s intellectual property and ongoing franchisee support;it also allows the franchisor to make a profit. MSF levels range from 1-8%, depending on the industry sector, and fees are usually payable monthly in arrears.
Some people refer to the MSF as royalty but this is misleading. While royalty income is a passive income, payment of the MSF entitles the franchisee to receive extensive ongoing support in all aspects of successful operation of the business.
Seen from the franchisee’s viewpoint, it is preferable for the MSF to be calculated as a percentage of the franchisee’s sales. Indeed, this is a key element of successful franchising because it links the franchisor’s income to franchisees’ business success.
- Other fees
Some franchisors levy fees for providing additional services, for example a centralised administration service. Others charge a renewal fee when the franchise agreement comes up for renewal but this is less common in South Africa than in some overseas countries, notably the U.S.
In our view, such practices are acceptable only if they are disclosed during initial negotiations and franchisees derive a clear benefit. Our sentiment is supported by the CPA which provides that all franchise fees must be fully disclosed upfront and must constitute reasonable value for money.
- The vexed question of confidential rebates
It is common practice among suppliers to offer franchisors financial incentives linked to network-wide purchases. This is acceptable provided that it is administered correctly. According to the CPA, franchisors are under an obligation to disclose confidential rebates received and how they intend to apply them. The Competition Act comes into play as well. It prohibits franchisors from compelling franchisees to deal with prescribed suppliers unless they can show that this is absolutely necessary to protect the brand or delivers other benefits.
Although the law is silent on this aspect, we’d consider it good franchise practice for franchisors to either share confidential rebates with their franchisees or allocate payments received to mutually agreed projects.
- Advertising fees
Although most networks levy an advertising fee, we left this topic for last because the resulting payments are not income in the hands of the franchisor. It may be convenient to make advertising fees payable together with the MSF but in terms of the CPA, franchisors are legally obliged to keep advertising monies in a separate account. The resulting fund must be used solely for the purpose of brand and product promotions that benefit the entire network. Moreover, the franchisor must periodically account to franchisees for monies spent and supply them with audited financial statements.
In the next article, we will examine what constitutes a fair and balanced franchise agreement. To find out more about franchising and especially franchise finance in the meantime, contact the Business Manager at the Nedbank Area Office nearest to you. For contact details visit www.nedbank.co.za or your nearest Nedbank branch.