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When running a franchise, a franchisee will run one of the franchisor’s branches. However, a portion of those profits will go to the franchisor in exchange for running that branch.
These are known as franchise royalties.
In other words, the franchisee pays money to the franchisor for the use of their business.
Franchisees will typically pay franchisors for a number of expenses, primarily when the business relationship begins.
Franchise royalties, however, are an ongoing fee for the franchisee when it is utilised. The most important aspects to understand about franchise royalties are:
- The nature of franchise royalties
- How they may differ from other types of royalty payments
- The distinction between franchise fees and royalty payments
- The purpose of franchise royalty payments
- Payment percentage
Franchise royalties are not a compulsory part of Franchise Agreements – in fact, some business owners may wish to skip this entirely and opt for a fixed monthly fee instead.
However, regardless of whether you are a franchisor or franchisee, it’s good to know about royalty payments and understand the role they can play in franchise relationships. Read on to learn more about how franchise royalties work.
What Are Royalties?
Generally speaking, royalties are payments made for the use of something. Usually, one party will pay another party a certain fee in order to utilise something they own.
Many industries use royalties as a payment method.
| Example For instance, let’s say you have composed an original piece of music and the local theatre would like to use it as background music for their next show. In this case, an agreement to pay royalties for each time your music is used in the theatre’s performances is applicable here. |
In fact, royalties are a common way to make payments in the creative industry. Many of the artists, writers or owners of works of music, television, books and film that we consume are often earning royalties from the use of their work.
There is no ceiling or minimum for the amount of royalties payable. Royalty payments depend on the parties, the scale of the use, the commercial value of the item being utilised and so on.
So, this is something that should be clearly set out in the negotiations and the agreement between the parties.
Do Franchises Pay Royalties?
Yes, franchises can have agreements to pay royalties.
Usually, the franchisee will pay a franchise royalty fee to the franchisor on a monthly basis. There is no obligation for businesses to have a royalty payment process, but it is something that many do like to explore.
A franchise royalty fee can aid the main business with expenses incurred by expansion to a franchise set-up, as well as provide franchisees with a larger connection to the head office.
What Is A Franchise Royalty?
Once a franchisor and franchisee have established their agreement and the franchisee operates the same business in a different location, they will begin to earn profits.
The franchisee will then pay the franchisor a percentage of those profits as a monthly payment, known as the franchise royalty fee.
Normally, the percentage of profits to be paid is around 5-6% however, it can also be as high as 15%. This number will depend on the business and what the franchisor and franchisee agree to
In many ways, franchise royalty payment works in a very similar manner to other types of royalty payments. In exchange for the use of the franchisor’s items – the business model, intellectual property, products, ideas and anything else that makes up their business – a franchisee will pay them a percentage of their earnings for as long as their agreement lasts.
However, it does differ to other types of royalty payments in fundamental ways as well – read on to find out more.
What Is The Difference Between Franchise Royalties and Franchise Fees?
Franchise fees are usually a one-off payment that is due when starting a franchise business. The fee is paid by the franchisee to the franchisor to cover costs associated with starting a franchise, such as:
- Lease Agreement
- Intellectual Property (you may need an IP Licence)
- Legal expenses
Franchise royalties, on the other hand, are an ongoing payment that generally does not have a fixed amount. Instead, it is a percentage. The amount of royalties will depend on the profits that are earned that month.
| Example Erin has invested in a clothing boutique franchise from her franchisor, Claire. According to their Franchise Agreement, Erin is to pay Claire 10% of the profits the boutique earns monthly as a franchise royalty fee. Last month, the boutique earned $10,000 in profits. As per their agreement, Erin pays Claire $1,000 as royalties. |
You may be wondering, “If a franchisor is already being paid a franchise fee at the beginning of the relationship, then why does an ongoing royalty fee need to be paid?”
The answer is that royalty fees not only allow the franchisor to earn a profit and act as incentive to continue growing their business, but it also allows them to keep investing in the business, which ultimately benefits all parties involved.
What Does A Franchise Royalty Payment Cover?
A franchise royalty payment will generally cover the costs of supporting the franchisees and the branches. These matters can include:
- Marketing costs (you may have a Marketing Fund)
- Training resources
- Equipment that has been provided
- Oversight or support
- Administrative matters
In other words, the franchisor manages a lot of the finances and administrative tasks that allow the franchisees to run smoothly, so the royalties work as compensation for these efforts.
How Do We Calculate Franchise Royalties?
How much you pay in royalties will depend on the type of franchise and its commercial capabilities. For example, a large franchise that has national or even global brand recognition as a brand will be more likely to charge a higher fee as they are confident in the profits their business will make.
A smaller business, on the other hand, will have a smaller fee compared to a larger franchise. This takes into consideration potential profits, risks and other financial aspects.
It’s always wise to seek the advice of a financial professional when calculating the percentage amount for the royalties to ensure you’re spending your money correctly.
Why Do Franchise Owners Pay Royalties?
As mentioned before, royalties allow owners to earn a profit from managing multiple franchises. It is essentially compensation for their investments.
The fee must be fair to both the franchisee and franchisor. A franchisee will require enough money to keep their franchise running smoothly and earn a profit themselves, too.
However, the franchisor must also receive enough to aid their future expansion. fee paid to the franchisor will not only allow them to gain revenue from it but also, equip them with more capital to invest in continuing to expand the business.
In addition to talking to a financial advisor, we also encourage you to chat to a lawyer about your options moving forward. This is because franchising can be a complex landscape if not managed correctly, and it’s always good practice to check that you’re compliant with franchising laws such as the Franchising Code of Conduct.
What Is The Difference Between Regular Royalties & Franchise Royalties?
Regular royalties are paid when something is used. Once it is no longer in use, there is no need to continue paying royalties.
However, a Franchise Agreement is a contract. So, a franchisee cannot simply stop ‘using’ the franchise in order to liberate themselves from paying franchise royalties.
Let’s look at this in more detail with an example.
| Example Allison is a wildlife photographer and Helen runs a well respected nature blog. Helen asks for Allison’s permission to use one of her photos on the banner of her website. Allison does not wish to sell the rights to her photograph but allows Helen to use it under a Licence Agreement. Under this agreement, Helen must pay Allison royalties from the money she earns from her blog every month. Helen agrees and this relationship continues for a few months until she decides to use a different photo by another photographer. At this point, Helen terminates her Licence Agreement with Allison, to which she agrees, and stops sending her payments for its use. |
In many cases, royalty payments stop as soon as the use for the item is no longer warranted.
However, franchises are bound by a much more complex agreement, therefore, the payments cannot be opted out of so easily.
Key Takeaways
There are many expenses associated with franchising a business, whether you are a franchisee or a franchisor. Royalties are one of the main fees, and it’s crucial that both the franchisor and franchisee understand how they work to avoid complications during the franchise process.
Details around franchise royalties should also be made clear in the Franchise Agreement from the outset. This is something that can be negotiated in the early stages, so make sure to carefully plan this out in light of your franchise’s budget.
We have a number of resources to guide you in various stages of the franchising process, such as:
- Selling A Franchise
- What To Do At The End Of A Franchise
- Legal Documents You Need For Franchising
- Franchise Agreements
- What Fees The Franchisee Has To Pay
- Terminating A Franchise Agreement
- What To Do With A Bad Franchisee
- Franchisees’ Legal Obligations
- What Are Franchising Royalties?
- Franchise Grant Process
If you would like a consultation regarding franchises and royalty payments, you can reach our franchise lawyers at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
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