Understanding FTC Guidelines for Franchise Fees

Understanding FTC Guidelines for Franchise Fees
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Irrespective of the industry sector, all franchise agreements involve payment of franchise fees. A franchise fee is one of many kinds of payments a franchisee agrees to make to the franchisor. These financial responsibilities create and sustain the franchisor-franchisee relationship. You should know an organization’s franchise costs before signing a franchise agreement. 

The Federal Trade Commission (FTC) requires franchisors to disclose all fees and expenses in their Uniform Franchise Offering Circular (UFOC) to potential franchisees before selling a franchise. This information must be accurate and comprehensive for potential franchisees to make educated choices.

What is the Franchise Fee for Initial Setup?

You pay the franchisor an initial franchise fee when you sign your franchise agreement. Fees vary per organization and usually reflect the franchise’s size and scope. Upon payment of an initial franchise fee, you become a member of the parent organization’s business family.

A franchise fee is one of three requirements for your new company to be a franchise. The FTC considers your company a franchise if it fulfills the following criteria:

  • You must be a franchisee to run a company and offer products or services connected with the franchisor’s trademark and proprietary systems.
  • The franchisor pledges to exercise considerable influence over your company or to help you in running your business.
  • During the first six months of operation, you must pay the franchisor at least $500.

Most organizations’ initial franchise fees cover more than entrance fees. This fee usually covers the application fee and allows you to utilize the franchise’s logo and business plan. It may also pay startup training, marketing, advertising, and other company support expenses.

Is there an Ongoing Franchise Fee?

Each organization’s continuing franchise costs differ. You pay continuing franchise costs as long as you remain a franchisee. Typical recurring franchise costs include:

Royalty fees

Royalties are usually calculated as a proportion of gross income. Although franchisors may set it at any proportion, the industry norm is between 4% and 9% of total sales.

Some franchise royalties are fixed. Instead, they’re set at a constant sum regardless of income. Depending on your franchise agreement, you may be required to make this payment weekly, monthly, or another time.

Royalties are the main source of income for franchisors, regardless of how they’re computed. Royalties help your franchisor grow and attract new franchisees. Your royalties payments may also entitle you to:

  • Ongoing training
  • Playbook revisions
  • Software updates
  • Business mentorship
  • Administrative aid

Advertising Fees

Advertising and/or marketing expenses are also recurring franchise fees. Advertising fees, like royalty fees, are paid every month and maybe fixed or based on gross sales, but usually at a lesser proportion.

Most franchisors pool all advertising payments into one fund to support national and/or regional campaigns. Franchisors who manage their advertising expenditures may be reimbursed.

The Impression of Franchise Fees on Profits

Ask an existing franchisee in the same company how their franchisor’s fees impact earnings. Inquire about the franchisee’s monthly income and capacity to pay the necessary fees. Find out whether they’re still profitable after paying the franchisor. Consider if this rate of return is acceptable to you as a new franchise owner.

A current franchisee can also advise you whether the franchise advertising costs are worth it. One of the benefits of buying a franchise is being connected with a well-known brand. During your financial planning process, ask existing franchisees whether they believe their advertising costs are utilized effectively to market the business.

Are Franchise Fees Negotiable?

For several reasons, franchisors do not discuss franchise costs. Under the FTC’s franchise requirements, a new franchisee’s significant modification or consideration must be presented to other potential franchisees. The franchisor must also offer the same deal to everyone else contemplating buying a franchise.

The franchisor must update the UFOC to reflect the reduced pricing before resuming talks with all prospective purchasers. Most franchisors won’t consider it.

It’s simpler to collect and manage fees when every franchise works on the same scale. Having uniform franchise fees saves the corporate staff time.

Offering new franchisees cash incentives may undermine the sense of community that helps franchisees succeed. Having a level playing field may encourage franchisees to work together for mutual benefit.

What Happens in Defaulting on Franchise Fees?

Following your first franchise fee payment, you’re legally obligated to pay your recurring fees on the dates and amounts stated in your franchise agreement. Missing a franchise fee payment may result in legal repercussions and a violation of your franchise agreement.

Depending on your franchise agreement, your franchisor may be able to terminate your franchise if you fail to make payments. Even if you feel the franchisor isn’t meeting their commitments, withholding franchise payments may result in termination of the franchise agreement and financial loss.

You should seek legal counsel if you can’t afford to pay continuing royalties or advertising costs due to poor income. You should call the franchisor and explain your issue. If your financial issues are transitory, your franchisor may be prepared to help you get back on track before continuing these payments, but this isn’t required.

Before you sign your franchise agreement, you’ll learn about your organization’s franchise costs. Understand the monetary amounts and the methods used to compute these fees. Ignoring your franchise payments commitments may sour your relationship with your franchisor and endanger your ownership.