If you want to start a new business and give it a better-than-average chance of being successful, a franchise business is a great way to get started. But if you plan your finances well, you have an increased likelihood of being successful. So, what is the cost of buying a franchise business? Let’s look at a brief outline.
A Summary of the Most Important Franchise Costs
Upfront Costs:
Franchise fee (e.g. McDonald’s franchise fee ranges from $45,000 to $2.7 million)
Equipment and inventory costs (e.g. Subway requires an initial investment of $116,000 to $263,000)
Renovations to the location (e.g. KFC may require up to $1 million in renovations for a new location)
Ongoing Costs:
Royalty fees (e.g. 5% of gross sales for Dunkin’ Donuts)
Advertising fees (e.g. 4% of gross sales for Taco Bell)
Training fees (e.g. 6% of gross sales for 7-Eleven)
Hidden Costs:
Legal fees (e.g. hiring a solicitor to review the franchise agreement)
Accounting services (e.g. bookkeeping and tax preparation)
Insurance (e.g. liability insurance for a restaurant)
Ongoing training and support (e.g. attending conferences)
It’s important to remember that the exact costs and percentages can vary a lot based on the franchisor and the industry. Before making a choice, it’s important to do extensive research into the costs involved with a particular franchise opportunity. Let’s look at these costs in more depth:
Up-Front Costs: The Price of Admission
When you think about how much franchising costs, the first thing that probably comes to mind is the upfront costs. When a business is set up and put on a path to making a profit, it will encounter many costs. These costs can add up quickly, but keep in mind that they are an investment in your business’s future.
A small to medium-sized franchise business with its own shop usually costs around £100,000 to start up. Most of the time, this money doesn’t come from the franchisees‘ own pocket. Instead, it comes from a local bank that has been impressed by a good business plan.
The business plan must include all the expected costs and profits of the business and a clear explanation of how the money will eventually be paid back.
The Lease
One of your biggest recurring expenses will be your lease. The lease is one of the fixed costs of your business. No matter how well things go, a lease that is more expensive than it needs to be will continue to cut into your income month after month, for a long time to come.
Many people who have started franchises that have done well have learned that you should spend as much time as you can haggling over the price of your lease.
Most leases have a surprising amount of flexibility, so take your time and talk to the owner to see what kind of arrangements you might be able to make.
Often, you can get a lower lease price for the first few months or years, until your business gets on its feet.
Furthermore, the lease price could be reduced if you add fixtures or make other improvements to increase the property’s value. If you’re going to fix the owner’s place, you might as well get paid for it.
Equipment and Inventory
This comprises the cost of all the materials needed to build a store on a site or turn a rented site into a store. This includes adding signs, front pieces, counters, tables, chairs, and anything else that gives the store its look and functionality.
If you want to build a restaurant franchise, which is one of the most popular but also one of the most likely to fail because of its high costs, you will need a kitchen with all new equipment, including counters, stoves or ovens, a refrigerator, and all the utensils and kitchenware that you need to make food.
Franchise Fee
The franchise fee, which is sometimes called the licence fee, is a special start-up cost for a franchise. The amount varies a lot between franchises, but it is usually several thousand pounds and gives the buyer the right to use the franchise‘s brand name.
In exchange for your franchise fee, the franchisor will support you in a number of ways and this is one of the reasons why people choose this over going it alone. This can more than make up for the fee itself, which may seem like a big cost. And it can be, based on the type of franchise you choose and how well-known its name is).
Ongoing Costs: The Price of Staying in the Game
Upfront costs are just the beginning – there are also ongoing costs which include royalties, which are usually a certain percentage of your gross sales, and advertising fees, which are usually a certain percentage of your total sales as well.
These costs may seem like a burden, but they’re a small price to pay for the help and resources that come with a franchise.
Once you’ve paid your franchise fee, bought and set up the location, and opened the doors so customers can start coming in, you’ve passed the first big hurdle towards having a successful business!
The next few months will show if you can figure out how much it takes to run the business and make enough money to cover those costs. Every business has some costs that can’t be avoided and are part of the business’s bottom line.
Obviously, you will need to ensure you have sufficient working capital to meet your ongoing costs, especially during the initial start-up phase. Most franchisees will need some kind of outside funding including bank loans to meet the financial needs of the business.
FranchiseRoyalty Fees
A franchise business usually comes with an additional cost of a percentage of your earnings that goes to the franchise company. These will be set out in your franchise agreement and are also known as Management Service Fees (MSF).
Because of this fee, you will continue to receive support from the franchise company in the form of, for example, special discounts on supplies that you need or access to a marketing portal or materials.
Types of Franchise Royalty Fees
Here are some of the most common types of franchise fees that come with buying a franchise business.
1. Fixed Percentage Royalty Fees
When you buy a franchise, you’ll give your franchisor a set percentage of your sales. For example, if you buy into a franchise that charges a 4% royalty fee, you will have to pay 4% of all operating revenue.
There are various ways to generate this money. Sales of goods, services, and memberships that you offer in addition to your main product or service.
When starting a company, a flat royalty fee or a variation on a percentage royalty fee is often best because it keeps costs low and lets you keep a positive cash flow. But because these fees are usually more expensive than other fees, they might not be right for everyone.
2. Increasing Percentage Royalty Fees
This type of franchise royalty structure pays the franchisor a variable percentage of gross sales based on factors influencing the likelihood of a franchise’s success.
Most likely, the franchise location is the thing that affects this model the most. If a franchise is on a busy street in a city with a lot of foot traffic, the royalty rate charged may be higher than if it’s in a more rural area.
3. Decreasing Percentage Franchise Royalty Costs
Even though these models sound like they are the opposite of Increasing Percentage Royalty models, they are not. With this model, the amount of sales a franchise makes determines the amount of royalty that must be paid.
If the franchisee sells more products and generates more revenue, the percentage of royalties paid to the franchisor declines. Most people think this model is good for both sides because it encourages franchisees to grow and make more money, which is good for franchisors as well.
A lower royalty fee may only apply for a certain amount of time. If the franchisee is still making a lot of money after that, they may be given another term at the lower royalty percentage rate.
If sales keep going up after that time, the franchisor may drop the franchise fee for good.
4. Transaction-Based Royalty Fees
Not all royalty agreements have to do with direct sales. For some companies that involve bigger-scale transactions (like the hotel industry), royalties may be based on a set fee per transaction. Even though these royalties are similar to fixed percentage royalties, they only take a set amount from each sale instead of a percentage.
5. Fixed Royalty Fees
Fixed royalties, not to be confused with fixed percentage royalties, are just a set monthly fee that a franchisee pays to the franchisor.
These royalties make sure that the franchisor gets paid every month, so there is no risk. But successful franchisees can keep a lot more of the profit than they could under other methods.
6. Minimum Royalty Fees
Minimum royalty arrangements are sometimes used along with another type of royalty, which is usually based on a percentage.
In these arrangements, a franchisee must make a minimum payment to the franchisor every month, even if their monthly sales don’t generate enough revenue to cover that payment under the percentage-based franchise model.
A minimum royalty agreement, like a fixed royalty agreement, puts all the risk on the franchisee and takes it away from the franchisor.
7. No Fee Arrangement
Since neither the franchisee nor the franchisor has to make these payments, they are not technically royalty payments. In this kind of model, a franchisee is often required to buy certain products or supplies from the franchisor.
Can a FranchiseRoyalty Fee be Negotiated?
Yes, a franchiseroyalty fee is negotiable. The majority of royalty payments are non-negotiable, although certain franchisors have clauses in their contracts that permit discussions depending on your financial situation or credit score.
Additionally, franchisors frequently set fixed fees that apply to all franchises and have upper limits on the lowest royalty rates they will accept. You might be able to negotiate a cheaper rate if you think you can but don’t get your hopes up, especially if your credit is anything other than excellent.
Advertising Levy
A franchise advertising levy is a fee paid to the franchisor to pay for advertising and marketing campaigns for the franchise business. This fee is usually a percentage of the franchisee‘s gross sales or income, and the franchise agreement usually has a clause about it.
It allows the franchisor carry out advertising and marketing for the franchise system as a whole.
This can save money for franchisees and make the marketing plan for the network as a whole more cohesive and effective.
The use of franchise advertising levies is common in many franchised business systems, particularly in industries such as fast food, retail, and hospitality.
Details of the advertising levy, such as how much money is collected and how it is spent, can be different from one franchise system to the next.
Local Marketing
This doesn’t mean that you won’t also need to do some neighbourhood marketing. Local marketing can be very important for small companies that want to reach their ideal customers in the area.
This may include tactics such as local SEO, community events, and targeted advertising. The franchisor may also offer training and support to help franchisees use these strategies well and succeed in their local markets.
Furthermore, they may give franchisees access to marketing tools and materials to help them promote their businesses.
Staff, Lease, Utilities and Taxes
Other fixed costs of a business are the cost of employees (you should always have a few more than you need, in case someone has to leave for some reason and you need someone to keep the store running), the ongoing cost of the lease (which you hopefully got at a good price), and the cost of utilities and taxes. All of these costs will stay more or less the same for as long as your business is open.
Your business needs to be able to handle these costs in order to survive. It’s important to review your costs often to make sure they aren’t eating up too much of your revenue and to find places where you might be able to save money without sacrificing the quality of your business. This will help you keep a healthy profit margin and make sure that your business will be successful in the long run.
Hidden Costs: The Price of Surprises
There are some hidden costs you should be aware of, even though the upfront and ongoing costs of franchising are fairly simple. Among these are the costs of insurance, legal fees, and accounting services. Even though these costs may not seem like much, they can quickly add up, so be sure to include them in your budget.
Legal Fees
Legal fees are an important hidden cost. Before you sign a franchise agreement, you should have a franchise solicitor look it over to make sure it’s fair and legally sound. This can cost several hundred pounds, but it’s an important step to take to protect your investment and make sure you fully understand the rules of the agreement.
In addition, once you come to renew your franchise at the end of the initial term, you may be required to pay some kind of renewal fee or other legal fee. This should be set out right from when you sign the franchise agreement.
Typically, franchisees have to keep detailed financial records and regularly report their earnings to the franchisor. This can take a lot of time and be complex, so many franchisees hire an accountant or bookkeeper to do it for them.
This can cost several thousand pounds per year, depending on the size of the business and how complicated the financial reporting needs are.
Insurance
Insurance is also a big secret cost that you should think about. Most franchisors require their franchisees to have public and/or product liability insurance, and often professional indemnity insurance, which can be expensive based on the type of business and location.
In addition to liability insurance, franchisees will need to buy property insurance, employers’ liability insurance, and other types of security to protect their businesses.
Ongoing Training and Support
Lastly, it’s important to think about how much training and support could cost in the long run. Many franchisors require their franchisees to go to training sessions or conferences on a regular basis, which can be expensive if you have to pay for travel and lodging.
Also, franchisees might have to pay for ongoing services like technical support, help with marketing, or legal advice.
In the end, the upfront and ongoing costs of franchising can be high, but it’s also important to think about the hidden costs that come with this business model. By thinking about these costs, people who are interested in becoming franchisees can decide if franchising is the right choice for their business goals and budget.
Saving Money on All Costs
Now that you know the different costs of franchising, you may be wondering how you can mitigate them. Here are a few tips to help you save money:
Look into different franchise options and compare them to find one with lower start-up costs.
Negotiate! Usually, you can’t negotiate the franchise fee, but some franchisors may be ready to work with you on other parts of the agreement. Some fees, like advertising fees, might be able to be lowered or waived.
Get financing. Many franchisors offer financing options to help franchiseescover the costs of starting a business.
Keep an eye on your inventory. Don’t keep too much in stock, as this can quickly cut into your profits.
Consider buying used equipment and inventory to save money on initial investments.
Plan and budget carefully to avoid surprises and unexpected expenses.
Join a franchisee association or network to benefit from collective bargaining power and access to resources and information.
Hire an accountant and a lawyer with a good reputation and a lot of experience to help you deal with legal and financial problems and ensure you comply with all rules and regulations.
Look into other finance options, like loans, grants, or donations, to supplement your own funds and reduce your reliance on high-interest loans or credit cards.
The Bottom Line
Franchising can be a fantastic way to start your own business, but it does have its own costs. By learning about the true cost of buying a franchise, you can make a better decision about whether it’s the right choice for you. If you plan ahead and make a budget, you can keep these costs in check and make your wallet happy.
Please note: None of the above constitutes financial and/or legal advice. We advise people to seek their own professional advice suited to their personal circumstances. You can find franchise specialist legal and accounting services in our directory.
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