smallbusiness.co.uk: Helping your business think big

The initial cost of a franchise with include the initial fee and, most likely, some kind of continuing fee (also called royalty or service fee). It’s hard to say what else a typical start-up package includes because there is so much variation from franchise to franchise, but the sort of items that could be part of the initial cost include shopfitting, equipment, initial stock and the initial franchise fee.

Initial franchise fee
The initial fee is what you are paying to be given the right to use the brand name within a certain territory and to be trained and provided with advice. The initial cost of a franchise falls within a huge range; it could be less than £10,000, for example, or as much as £5 million, but according to the latest survey by the British Franchise Association, it will typically be around £40,000. Usually, the initial fee is between five and ten per cent of the total investment but can be as much as 40 or 50 per cent.

Service fees
An ongoing service fee, payable weekly or monthly to your franchisor, can also vary quite a lot, from nil up to 20 per cent of sales, but is probably on average around seven or eight per cent. The fact that the service fee is nil does not necessarily mean that all you pay will be the initial start-up cost. Franchisors can also be paid by using mark-ups on products and equipment.

A low service fee is not necessarily an advantage for you. It is crucial that the franchisor retains an ongoing interest in promotion and improvement of the business format, and that will only be achieved by the reliance on some sort of continuing payment from the franchisee.

Franchisors usually prefer to base the service fee on sales rather than profits. This is because monitoring the franchisee’s accounts to ensure that the franchisor is receiving the proper amount can be time-consuming and expensive. If the fee is based on profits rather than sales, this monitoring has to apply to costs as well as sales, doubling the difficulty of the task.

However, a fee based on sales can be disadvantageous to the franchisee. If the costs of the enterprise prove to be higher than forecast, paying the service fee could be an onerous burden for the franchisee.

You should not underestimate the size of the service fee if it is based on sales not profits. If, for example, your costs are 60 per cent of your sales value, a service fee of ten per cent of sales translates into a service fee of a quarter of the profits you make. Work out the figures before you sign.

One point to watch out for is what happens at the end of the original franchise contract if you want to renew. Does the contract allow the franchisor to increase the size of the service fee? Try to negotiate on this, as you do not want a bigger percentage of your hard work to be passed over to the franchisor.

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