October 17, 2023

Do You Know the Costs of Buying into a Franchise?

Owning a franchise, whether it’s a branch of a national burger joint or a hardware store, is an appealing proposition to a budding entrepreneur. In the best of scenarios, you can reap the benefits of an established brand, and get assistance in many other aspects of running a business. In fact, 76% of respondents to the 2023 Annual Franchise Survey, conducted by the International Franchise Association, cite “sharing best practices with other franchisees” as the top advantage of being a franchisee.

However, along with these advantages come some costs you might not expect. Knowing the following potential expenses from the start can help you adjust your business plan to account for them.

Managing the up-front franchise fee.

In addition to the basic franchising fee — the cost of buying into the brand — franchisors may charge legal fees on your agreement. Some franchising companies may offer financing for part of your fee, but not all of it. After all, they want you to have a personal financial stake in the venture. With this in mind, some franchisers won’t allow a new franchisee to finance their franchise fee.

Paying ongoing royalties.

Royalties are the ongoing fees you pay for piggybacking off the success of the franchise, including the brand’s intellectual property like its logo, advertising, and marketing materials. (74% of IFA survey respondents say marketing assistance is a top franchising benefit.) Assessing royalties is how the brand reaps its core revenue. Most typically, the royalty is a percentage of sales. However, some franchisors may charge a base residual and a percentage of sales. Get a breakdown of royalty charges before signing an agreement.

Building your space.

In most cases, you’ll assume the burden of building out your business location, in line with the franchise’s brand specs. Before entering into any agreement, determine related building costs such as your real estate agent’s commission, applying for and getting construction permits and hiring construction and interior design contractors. The franchisor may have tips on vendor selection.

Buying equipment.

Some franchise agreements include equipment as part of the initial franchise fee. But that’s not always the case, and you may need additional equipment any way: If you open a gym, for example, the franchise may include exercise equipment in the franchise fee; if you want to add vending machines or a juice bar to drive sales, that’s up to you. Note that franchisors may require that you purchase the same equipment as other franchisees. They may even have set suppliers.

Sourcing materials.

If your business sells products — anything from hamburgers to wrenches, you’ll need to source vendors. Franchisees often require you to use specific suppliers, limiting your negotiation power. And since the franchisor’s reputation is at stake, it may opt for higher quality and thus more expensive materials. Establish a good working relationship with your vendors early on. As your business proves itself a stable customer, these vendors may offer you discounts.

Participating in the franchise community.

The franchisor may require you to attend trade shows or internal meetings. Training and events can present opportunities, and you’ll always learn something new. Discuss these expectations before deciding to join the franchise. Travel may in fact benefit your business. Talk with your accountant about how to classify these expenses for tax purposes.

A franchise may be perfect for entrepreneurs looking for a proven business formula. However, if the costs end up being too high for your to stomach, it’s better to know before signing on the dotted line.

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The franchise disclosure document (FDD) is a crucial document when considering this opportunity. Franchisors are required by law to disclose all the fees and other aspects of the agreement. The FDD is where they publish that disclosure. Any potential franchisee should take this document seriously.