All About Royalties
There is one topic that is on the minds of virtually every person who is interested in franchise ownership: Why do I have to pay royalties?
How much do I have to pay? For how long? And again, why do I have to do this?
Right off the bat, most people are confused about royalties. You are the one doing all the work, and you are the one making the money. Now the franchisor wants a cut?
Yes, yes they do. But you are probably wondering why they are entitled to it.
What Are Royalties?
Let’s start at the beginning. A royalty is a fee that you as a franchise owner are going to pay to the franchise weekly, biweekly, or monthly at the most.
First off, you are going to have to pay royalties as long as you are a franchise owner. Deal with it. You will typically pay some percentage of revenue, usually a single-digit number – anywhere from 5% up to 8% or 9% is standard – back to the franchisor as royalties.
So why do we do this and what is the benefit, if any, as a franchise owner when it comes to paying royalties?
Why Do Franchise Owners Pay Royalties?
Let’s start with the question that is probably on your mind: Why are we paying this?
Well, the franchisor has created this system, this business model, and has been able to replicate it so that YOU as the franchisee can come in and be successful. That has taken years and hundreds of thousands of dollars for that franchisor to do. The royalties are one part of how they, as business owners, make their money.
Keep in mind that franchisors do not really make money off the franchise fee – that is basically just the cost of finding you and compensating all of the people that helped you become a franchise owner and get yourself open for business. Not only do they not make money on that process, they often lose money on it.
The franchisor has also taken years – prior to becoming a franchise – to simply create the business. They started everything from scratch.
Example: Tim’s Sandwich Shop
Let’s say that I start Tim’s Sandwich Shop because I think I make a really good sandwich. Before I even get open, I have to figure out a bunch of different things. Where do I buy the napkins? What about the meat, the cups, and the bread? What am I doing for a website, a logo, or any of the other marketing things? What about training – how do I hire my people?
With every last thing, I am trying to figure it out from scratch and hope that it works. Then, once we get open, we can see that, “Hey, people do like our sandwiches. They keep coming in.” Now we are going to continue to grow and expand the business.
Maybe we will open a second location in town. It’s kind of like testing the water: Can we really replicate this in another location? Do we have all of the systems in place to bring on new people to make the sandwiches at every location?
After a couple more years of that, then it is time to really turn Tim’s Sandwich Shop into a franchise and replicate it. So what does that look like? In most cases, franchisors have to spend hundreds of thousands of dollars to build out the business. That means creating standard operating procedures, training manuals, and everything else that needs to be replicated in any location around the country with anybody coming in as a franchise owner.
If that sounds like a huge undertaking, that is because it is. And those tasks are not the only things they need to take care of…
There is also the legal side of things: the Franchise Disclosure Document (FDD), all of the marketing materials, the Franchise Agreement, etc. Plus, we are now going to need people in place to work on the franchise development side to find our new franchisees, the operations side, the marketing side, training, tech – all kinds of different things. That is all money that we are going to invest as a franchisor before we ever have a franchisee. This really can take years and hundreds of thousands of dollars to do properly.
Once we do have franchisees, the royalties are our way of making money. We created all of this and we invested all of the time and the money into it. Just like any business owner – franchisor, franchisee, or a mom-and-pop shop – the goal is to make money. That is the whole point of owning a business.
Now you understand the backstory of why franchisees pay royalties. Is that good to know? Of course it is. But as a franchisee, do we really care all that much about how much time and energy and money the franchisor spent? No, because now money is coming out of our pockets and going to them.
So what is the benefit to franchisees, if any, from paying royalties?
How Do Royalties Benefit Franchisees?
Any franchisor worth their salt is going to understand that the way they make money is through their franchisees making money. Happy franchisees, happy franchisors. So part of that money from the royalties is going to help YOU.
It is all a part of that infrastructure the franchisor has – things like their internal staff for training, any sort of operations support, the marketing team that they have, and all of the tech support that is mixed in there. Many franchises will even have business coaches that you can work with to help you succeed. All of those things are being paid for by those royalty dollars.
Now, take any of those things that the franchisor is providing for you when you pay into the royalties. Could you have those things on your own? Sure, you could.
Do you want to hire a qualified business coach? That might be $3,000 to $5,000 per month if you are just a mom and pop shop. But when you go through the franchisor, you are paying a fractional cost of that. It is the same thing if you want to outsource marketing to a third party group that you do not have anything to do with – again, you have that support from the franchisor, so you are getting it at a discount.
Another benefit? Access to national accounts with vendors. We are going to give you the best vendors to buy the napkins from when you franchise Tim’s Sandwich Shop. You are going to get them at a better rate than you would if you just did it yourself.
Royalty dollars are going into all of those mechanisms for the franchisor to support you, the franchisee. Yes, it is going to be coming out of your pocket and going to the franchisor, but it should be contributing to all of those mechanisms that are in place to help YOU grow your business.
So the next time that you look at royalties and think of them as a burden – don’t.
I can’t stop you from thinking that way. But it is important to remember that royalties are part of a system that is built to help you as the franchisee.
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