Making Sense of Franchise Fees

Buying a new franchise requires a considerable investment. Understanding the different fees involved can aid franchisees in making the right decision.

Making Sense of Franchise Fees

After a long period of conducting research to find the franchise that suits your business needs and personality, it’s time to hand over a large sum of money. But how do you know if you are paying a fair price? And are you getting value for your money?

Franchisees need to take the operating costs into consideration when deciding whether or not to buy a franchise, but they should also look at what they are required to pay the franchisor upfront as well as on a monthly basis before they apply for franchise finance.

The upfront franchise fee

According to Anita du Toit, partner at Franchising Plus, with the Consumer Protection Act coming into being, a franchisor will be required to describe exactly how the upfront fee is allocated.

She says that in most cases a portion of it is a licence fee which allows franchisees to use the brand name and gives them access to the company’s intellectual property. Some of it covers the cost associated with start-up assistance, including project management or liaising with architects and builders. It can also be used for initial marketing support for the launch of the franchise, and the initial training.

Du Toit advises that franchisees ask what this training entails.

Bigger, established brands or franchises in lucrative areas charge higher fees and Du Toit says they have a right to do so, but should disclose the reason for charging the higher fees to the frachisee.

Vera Valasis, executive director of FASA, says franchisors have different views on the upfront fee. She explains that there are different models in that some charge an upfront fee, and some franchisors don’t charge an upfront fee or royalties but build commission into a product. She says the upfront fee is not related to goods in return as the amount depends on what brand you get into.

Claus Kuhl, managing director of Java Brands, says once a franchisee pays the upfront fee they are initially given a disclosure document. “Once they are approved as a franchisee they would receive a comprehensive induction session,” he adds. Kuhl explains that the upfront fees are determined by taking into consideration the costs associated with training, administration and project management. He says upfront fees are generally revised annually to ensure that they remain relevant and market-related.

Glenda Zvenyika, marketing communications manager for BP, says the upfront fee gives franchisees access to the business, in other words, the licence to operate a BP franchise as well as in-depth training on how to operate a BP franchise.

Ongoing franchise fees

In most cases, the franchisee is required to pay certain royalties to the franchisor for the various services provided. These are usually worked out as a certain percentage of the franchisee’s turnover, but can also be a fixed amount. “We dislike fixed fees.

It doesn’t incentivise the franchisor to help the franchisee achieve better performance,” says Du Toit. She adds that it is also fair if the franchisor benefits as the franchisee grows, because they put a lot of effort in to make sure the franchisee is successful.

According to Kuhl, Java Brands’ ongoing fees are reviewed periodically but do not tend to change often as they are generally contained within a five year franchise agreement. Zvenyika says: “For a convenience store, the fees currently payable are 11%.”

She explains that franchisees are essentially paying for use of the BP Express brand, including rentals as the layout and equipment are installed and paid for by BP. Further, she says a portion of their fees goes to marketing material and support, including through-the-line advertising support.

Management services fee

The management services fee is payment for services provided by the franchisor. This comprises general support services and having access to head office support. Franchisor support staff, referred to as field service consultants, should visit stores on a monthly basis. This should not only be done for quality control purposes, but also to discuss things like performance or local marketing opportunities.

Marketing fee

The marketing contribution is usually paid into a separate fund and used by the franchisor for national marketing campaigns, explains Du Toit. Valasis says in most instances, franchisors use this money at their discretion as they see fit.

“The owner of the intellectual property and know-how has the expertise so it is their decision how the funds are used. They can take advice from a franchisee, but the decision ultimately rests with
the franchisor.”

Other fees

Du Toit says some franchisors charge an admin fee, but this is usually if they perform certain functions for the franchisee like book-keeping. However, she explains that this is not the norm. This can be charged as a percentage or fixed, but should be cost-based for the franchisor to recoup costs.

Franchisors could also require franchisees to save up for revamps, which may happen every five years at renewal or when the brand and corporate identity is updated. Revamps can be draining if they are not provided for or planned, so some franchisors ask franchisees to contribute regularly towards them.

A trend in the US, which has been slow to take off in South Africa, is the charging of a renewal fee. “Franchisors have the right to do that, but it has to be noted in the disclosure document and franchise agreement,” says Du Toit. This fee is normally the same as the upfront fee at the time of renewal.

Do the research

Franchisees need to do thorough research before paying any money. Du Toit says franchisees should look for transparency from franchisors. Franchisors should clearly outline what a franchisee can expect for each of the fees. Franchisees can also look at what is market-related by researching what other franchises in the same sector are charging. “The question to ask is ‘what am I receiving for my fee?’”

According to Valasis, all fees should be in the disclosure document. She says the franchisee should have a clear breakdown of the fees as well as details on when they should be paid before they are required to put any money into the business.

Why should you pay?

While buying a franchise can be expensive and a percentage of turnover has to be paid to the franchise head office, buying into a franchise is buying into a proven business concept. “The market is already aware of the brand so you know you can achieve certain levels of profitability,”
explains Du Toit.

Further she adds that establishing and developing a brand from scratch is very expensive and potentially difficult for an individual.

“The negotiating power a group has will also get you better rates and prices from suppliers. It is a bit more expensive to buy a franchise than starting your own company, but your potential to succeed is greater,” says Du Toit.

Can you afford it?

Franchisees should not only look at the upfront and ongoing fees to determine whether or not they can afford a franchise. Franchisees are also required to cover the start-up costs, and some of this has to be money they already have.

“There is no such thing as a 100% loan,” says Du Toit. She says banks are more open to lending money to franchisees than start-ups, as around 80% of franchisees succeed. Banks are usually eager for the business and have dedicated franchising divisions.

However, most banks want the individual to take some risk too, so most franchisees are required to contribute around 50% of the total investment as their own contribution. Du Toit says paying back a 100% loan is also not realistic; the business won’t have enough free cash available to service the loan.

When applying for a loan, if the upfront fee is more than R200 000, it is possible that the bank will question the fee and further research will need to be done to determine whether or not this is a fair price.

Franchise Zone
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Franchise Zone is published by Entrepreneur Media SA. It offers advice and franchising opportunities in South Africa.

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