Paying the franchise fees

How do you know if you are paying too much for your franchise? Manzoor Ishani reveals the golden rules of franchising to ensure you are getting a fair deal

The golden rule of franchising is that franchisors should only stand to make money if their franchisees make money. This ensures that franchisors have a vested interest in seeing their franchisees' businesses grow. Another golden rule is the franchisor should not extract payment from its franchisee, by way of profit, from the same source twice.

If the franchisee's main source of income is from the sale of products, which a franchisee is required to buy only from the franchisor, it would be wrong for the franchisor to also extract an additional fee. To do so would mean the franchisor taking a profit from both ends of the transaction, ie, a profit when the franchisee buys the products from the franchisor and a percentage of the sale price when the franchisee sells the same product to the customer.

In the previous example, at least the franchisor's income is geared to the level of business conducted by the franchisee, but what if a franchisor requires payment of a fixed fee (by way of ongoing franchise fees) from its franchisee, irrespective of the level of the franchisee's turnover? Such a structure is not unethical per se, but it is frowned upon and it does place upon a franchisor an obligation to justify its need for such a structure.

Two types of such a structure seem to be the most common. The first is where a franchisor imposes a fixed fee on a franchisee by way of an ongoing franchise fee. The fixed fee structure is very simple. It requires the franchisee to pay to the franchisor a fixed sum at regular intervals (usually monthly). The structure usually provides for some form of uplift during the period of the agreement, usually annually and usually by reference to some formula. The disadvantage here is that there can be less incentive for the franchisor to support its franchisee.

There are, however, some advantages depending upon the nature of the business. The franchisor does not have to worry about the process of verification, the monitoring of the franchisee's turnover levels, etc. The franchisor receives a regular income irrespective of economic conditions and, if they get the formula right, it will take care of the effects of inflation. The franchisee can treat such a fee as a fixed overhead and this can act as a motivation for the franchisee who knows that the greater his turnover the larger will be the proportion they can retain.

But is such a scheme justifiable? The answer is yes. Such a scheme is most commonly found in low tech franchises that are uncomplicated, where the franchisor has little to give to the franchisee by way of ongoing support once the training is completed and which involves cash transactions.

The second is a royalty type payment taken by a franchisor as an ongoing franchise fee but with a fixed minimum fee. This is an entirely different matter and should be treated with great caution. Again much depends on the nature of the business and the circumstances. On the odd occasion that one comes across such a structure (and they are rare) the level of the fixed minimum fee is usually extremely low. Furthermore, there is usually a quid pro quo in that in return the franchisee is granted some degree of territorial exclusivity.

Fixed fees are rare but nevertheless they do exist. Prospective franchisees should tread carefully and need to base their decision (as to whether or not to buy a particular franchise) on sound professional financial advice.

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