How Franchisors Calculate Royalty Fees

Royalty fees are where franchisors make money. Whereas the initial franchise fee covers the startup costs for a franchisee, and ongoing fees such as technology or software access are often paid to the suppliers of those services, the franchisor earns the royalty fees. That revenue, however, doesn’t go directly into someone’s pocket; savvy franchisors reinvest in their operation to make it more attractive to sell and retain franchisees.

This is why it is important to set a franchise fee that provides a profit while also supporting the expense of franchise development initiatives. This requires being knowledgeable about the financial aspects of a franchise operation. Charge too much and potential franchisees won’t see the value in what they’re paying; charge too little and you won’t be properly financed to build your brand.

Understanding the establishment of fees in a franchise is critical to your success.

Why Fees Matter in a Franchise Relationship

There are different ways to grow a business and franchising is one of them. To meet the requirements of the Franchise Rule, as governed by the Federal Trade Commission (FTC), franchisors need to meet three criteria:

• Granting the right to use the franchise’s proprietary assets
• Establishing and enforcing brand requirements to use the proprietary assets
• Securing a financial relationship between the franchisor and the franchisee

The financial relationship consists of the initial franchise fee, and ongoing fees, including royalties, that continue throughout the franchise agreement term.

What Royalty Fees Support

Franchisors levy royalty fees in return for granting franchisees the license to use intellectual property, operational framework, and assistance services. These royalties are commonly calculated as a percentage of the franchisee's gross revenue (total sales) and are in the range of 4%-8%.

They are paid periodically, usually every month, throughout the franchise agreement term.

Royalty fees can support building brand awareness (marketing) and to explore new technology (apps and operating systems) that benefit the franchisee network. 

94% of franchise organizations charge a royalty fee with the average being 6% of monthly gross revenues. 72% of organizations charge a national advertising fee that averages 2% of gross revenues.

What Factors Go Into Setting Royalty Fees?

Royalty fees are determined by a number of factors. These include:

• Industry Percentages. Taking a look at what other franchises in the industry charge can provide a basis for what prospective franchisees should anticipate.
• Value of the Brand. If a franchisor has strong brand recognition and a strategic marketing plan, it can support allocating a portion of collected fees to provide high value to the franchisee.
• Support. If the ongoing support offered to franchisees is substantial, and the franchisor incurs expenses related to the resources to provide that support, it can be justified with an ongoing fee.
• R&D. Franchisors who are committed to finding new and improved ways to keep their brands innovative and industry-leading will use royalties to continue that work.
• Profit-Generating Performance. A franchise business model that shows consistent profitability likely contains all the above points, and that has a strong value in attracting new franchisees and keeping current franchisees as enthusiastic ambassadors of the brand.

Higher Royalty Fees are Not Bad

The U.S. Small Business Association shows how potential franchisees should not be deterred by higher royalty fees. Two examples are provided to explain royalties.

In the first example, if a food franchise has a gross annual revenue of $1.5 million, and the royalty is 5%, the franchisee pays $75,000 in royalties for the year. 

In the second example, if a business consulting franchise had a 10% royalty, that might seem high. However, the gross annual revenue may be at $300,000, which means the franchisee pays $30,000 a year in royalties.

In the first example, it will take a lot more work (and expense) to invest in the marketing and brand development of a food franchise as opposed to the consulting service. That’s how setting a fee for royalties becomes strategic.

Franchise Genesis is Your Franchise Development Advisor

When someone is looking at a franchise opportunity, they are going to dig into the financials, and that includes evaluating the royalty fee. A franchisor needs to provide enough value in the royalty fee that the franchisee is confident it is a beneficial part of the investment. Knowing how to set that fee appropriately is important, not only for attracting potential franchisees but also for sustaining a profitable franchise business.



The consultants at Franchise Genesis work with new, emerging, and established brands every day in the franchise development process. Being able to show the value of your franchise is important in a marketplace with 750,000+ brands all going after that same eager entrepreneur. 

We know what it takes to turn a small business into a successful franchise and how to make established franchises more successful. We encourage you to connect with us for a discussion.