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uber doesn't fit into one of these franchises, how to start a business
-What's up, guys? My name is Daniel McKenna. I'm the Executive Producer here at Thrive 15. And my cooking skills include macaroni and cheese and egg sandwiches, and that's about it. But today, we're sitting down with Clay Clark and with Terry Powell talking about franchising, how to start a business and the four most common types of franchise fees. Now, franchising info, you want to know, comes from Terry. Check this out.
Once you delve into the world of franchising, you will know there's some fees associated with using the brand and using the system you need to run a successful franchise. Today, we're going to talk about what those most common fees are so that you are prepared as you start your business. At Thrive, we believe knowledge without application is meaningless-- meaning if you don't take the time to learn something today and then apply it to your life or your business, today's lesson is going to be more meaningless than the new Rodney Dangerfield clothing line.
-Terry, Powell, how are you, my friend?
-Good, Clay. Great to be here.
-Today, we are talking about franchising 101 and the four most common franchise fees. I think when a lot of people think about buying a franchise, they hear somebody, they Google search it, someone says, yeah, well, the fees will kill ya. Or there's always negativity about anything. But the franchise fees are something that I think there's a lot of misinformation about. So today, we're really going to dive into these fees. But before we do, I want to clarify-- I've heard at least almost a half dozen people who keep referring to you as the godfather of franchising. You don't look old enough to be the godfather. But how did you get this title? How long have you been doing this, my friend?
-Actually, a long time. I've been doing this for 30 years. And back in the day when we started this, there really wasn't many companies that provided the type of coaching and franchise services that we do. So as being on the forefront of that in the early stages, that's really how the title came about.
-Well, we're going to go ahead and tackle these four kinds of franchise fees like an all pro linebacker, really. We're going to just knock it out here. So Terry, a franchise fee is the upfront fee charged when you purchase a business. It's basically the amount of money you pay in order to secure the rights to work with the brand for a given period of time.
Terry, I've heard many franchisors over the years say that these fees are not really a profit source for them. And originally, I thought, come on. You're charging a lot of money here. You've got to be making some money. But rather, the franchisors have said these just cover the cost of the infrastructure needed to support franchisees and to get them going.
TERRY POWELL: Yeah.
-Is this generally the case from your experience? What do these fees go to cover here?
-It's always the case. What we don't take into consideration is the franchisor has to make that investment in advance. And we're talking hundreds of thousands of dollars just to be able to offer the very first franchise, not knowing whether anyone will actually invest in it. So they're investing hundreds of thousands of dollars to get to that point. And now they start charging fees, a franchise fee of $25,000, $35,000-- they're really looking to recover that and to bridge the first stage of that relationship when the franchisee is not generating that many dollars in the first few months and there's no royalties coming in. That's designed to recover and bridge that gap to royalty stream.
-And when you buy a franchise, there's this thing called the franchise disclosure document.
TERRY POWELL: FDD.
-FDD. And in this document, it's very transparent. You have to have this document before you're allowed to buy a franchise. And it's a federally regulated process. But you're going to know what these fees are. You're not going to be blindsided by the fees, right?
-Yeah. There's no way that you can enter into a franchise relationship with not having been disclosed all of those.
-But sometimes, they'll break these fees up into different line items. You might have one called the territory fee, or the training fee. What are the kinds of fees that are typical so I know that I'm not getting bogus charges if I'm looking through this FDD or something?
-The most common are the franchise fee and the ongoing royalty. And then there will be some other subsets of that. Typically, there will be some sort of a brand building fee. In some cases, they'll refer to it as an advertising fee depending on what they're using it for. But typically, it's related to a commitment that each franchisee makes to a fund that is used to build the brand that everybody is invested in.
-OK. And typically, you have to pay these fees to get into the game, so to speak, or to get into the club. You can't just open up a franchise. You have to pay some of these fees to get going. Now, here's the fee structure number one. This is royalties. From a definition standpoint, royalties are the monthly or weekly payments that the franchisees pay to the franchisor for the life of the franchise agreement. Terry, explain to me what these fees are typically used for by the franchisor and how it happens.
-Yeah, that's a great question, because the ongoing royalty is really the essence of why companies decide to franchise. That's really how they become profitable to get a return on their investment. So it really is-- because it's an interdependent relationship, it's crucial to understand that the royalty is the key. Because the franchisor is, in many cases, more dedicated to making sure that you're profitable and covering your expenses and managing all the elements of the business so that you can be profitable. Because then they get to take a small piece of that. And that's really how they build return on their investment.
-I don't want to skim over this without the Thrivers watching this really getting this, because I think that I used to see it incorrectly. And I think that my ignorance of this area, it causes you to kind of misjudge, or miss-- you almost see opportunities incorrectly. But they're not making money off of the initial franchise fee. Their money is made of the royalty, right? So they want you to be successful. This is how they make money, is off this fee.
-I've had many a client say, you know, I really would like to do more than one unit, but I am concerned about not being there watching the cash register every day. So I always ask the question, well how important do you think it is that the franchisors develop systems and controls to watch that cash register for you? Because if it's not being watched, they're not going to get their share of it. So there's a lot of elements that tie into that success.
-What's the average royalty percentage of gross sales that I should expect to pay to the franchisor if I decide to go out there and buy a franchise?
-It'll range, typically a low of about 5%, and can be a high of 15%. Depending on what their franchisor is providing in addition, related to that royalty.
-So 5% or 15% is sort of that. And again, some businesses it's higher, some it's lower. So no matter what kind of franchise you're looking at buying, or which one you maybe own, 5% to 15% tends to be sort of that average.
-And at one point, 7-Eleven was charging a 75% royalty. And people said, how could that be? But they were also providing all the elements that business owner needed, including their rent, it actually covered the cost of goods for what they purchased. Everything was tied together for them, and all they needed to do was share 75% percent of the revenues, and the other 25% stayed with them. Now that's an exception to the rule.
-Now on behalf of the common man watching this, and on behalf of myself, I understand that there's essentially two different types of royalties out there. You've got basically a percent-based, or there's a fixed royalty. Can you walk me through what a percent-based royalty is, or how that works?
-A percent base is what we're just describing, is that based on your monthly-- typically your monthly-- revenues, you will submit a royalty payment to the franchisor based on the license agreement. If it's 5%, you do $100,000. Obviously you're going to calculate that, and it's going to be due to the franchisor. Typically on a monthly basis. Some franchisors require it to be submitted weekly electronically. More and more of those are happening.
-Now what is a fixed royalty?
-Some franchisors just charge you a flat rate monthly as your Royalty, regardless of how much business you do. I can see other could motivate you to get serious and start selling some stuff, if you have a fixed monthly royalty you're paying. It can be beneficial, and there are a few franchisors that find that that's the best way to, in their particular industry, operate their relationship around royalties.
-In your mind, which one is more common, the fixed or the percent?
The percentage is by far more common.
-Now, I've seen in many cases within the franchising world, where the amount is reduced over-- To give an example, like maybe your first $100,000 of sales it's 5%, but then your next $100,000 is 3%, and the next. Do you see that a lot, or is that common?
-It's fairly common. Even in our own companies, our franchises, we do a scale where we incentivize them to do more business. And they pay a lower royalty percentage as a result of that.
-So the fabulous fee structure number two that I want to dive into, we talk about it just a little bit there, is this whole fixed royalty. So the fixed royalty thing, I want to get into the ins and outs of this. Because I think a lot of people who maybe are looking into a franchise that has one, they might think this is a bad deal. Or maybe some people who own one may think it's a bad deal. What is the benefit of having a fixed royalty for the franchisor?
-For the franchisor is predictability. And also, incentivizing. It as a motivational and incentivize aspect to have franchisees actually aspire to grow to a higher level than they might normally. Because it will be a reduced expense for them. In a percentage royalty, the more they do, the more they pay. So there's benefits to the franchisor to fix that. It has a nice relationship aspect to it. The downside is in the early stages when a franchisee is just coming on board, they sometimes are reluctant about that commitment. They're not sure what they're volume's going to be.
-What about from the franchisee perspective? How is a fixed royalty of benefit to them, or how could it be perceived as a bad thing?
-Predictability, and the idea that, in many cases, franchisees that are more successful-- meaning they're leveraging the system more, or doing more volume-- actually require less support and help from the franchisor. So having a fixed can also help you understand that.
-I heard this commentary about four or five months ago. In preparation to interviewing you, my antenna goes up. I'm thinking, OK, we're going to interview the godfather of franchising. So I'm mentally, the last few months, kind of thinking about it. And I talked to this guy.
He was explaining to me that he has found a franchise that he loves because there's no ongoing franchise fee. And so I'm thinking, well, if the franchisor doesn't make any money by selling a franchise really, it doesn't make sense. Have you heard about these kinds of things? Are people really doing this?
-It's not that common, but they're out there. And typically the way that works is rather than charging you a royalty, they have a relationship, that we spoke about earlier, about where they require you to purchase certain things. So the franchisor is bringing certain things to that formula that the franchisee is acquiring or purchasing that is enough of a relationship commitment that there's not an additional royalty needed on top of that.
-Let's pretend for a second-- this is an example-- let's say I have a landscaping service that's a franchise. It doesn't have a franchise fee. Maybe I say you have to buy lawn chemicals from me. And then on every chemical that you have to buy from me, I maybe have a two times markup. So because you keep buying a ton of sod, and chemicals, and whatever, I make enough margin on the products you're required to buy that it's sort of like a fee without being a fee.
-Yes, its' a replace of the royalty percentage. But in the example of that, the good news is that whatever the franchisor is requiring you to purchase, they have to disclose what their markup is. So you likely would not ever see a markup of two times. But they'll give a fair markup, which should be the equivalent of a royalty stream.
-I kind of look at this as like there are states that charge no income tax, but they usually have some intense property tax. And so you're usually going to pay tax. I mean there's no tax free-- The company, if they're going to offer you support, training, systems, growth, and branding, they're going to have to make money somehow.
-And they're also going to leverage their buying power to help you save. So yes, they're in business, as all businesses need to be, for results. And those results are return on investment.
-Now, we're into fabulous fee structure number three-- the national advertisement fund or the advertising contribution fee. The advertisement contribution is a stated amount of money that the franchisee gives the franchisor on a regular basis for the purposes of advertising the brand. Terry, is this just another source of advertising for those franchisors? Or what is this all about?
-Well, the advertising is not for the franchisor directly. The advertising is designed to benefit the franchisee. In fact, those funds that they collect are actually kept separate from their audited business funds. And they're audited separately.
So they have a lot of restrictions in the way they can be used and how they need to be accounted for. So they're investing that money. The franchisor is collecting that money and investing it for the benefit of the franchisee to drive business and brand awareness for that collective group of franchisees.
-Let me see if I can get an example-- if I'm getting it right here. Every time I turn on the radio, I go to ESPN. I listen to a lot of ESPN on the way to work. It's nice, shallow-thought stuff. It kind of clears my mind while I'm driving.
And I'll listen to Mike and Mike a lot. And they'll have these Subway commercials that are always on. Are all the franchisees throughout the country paying a little bit of money that goes towards buying these advertisements? Is that kind of what we're talking about?
-Absolutely. Or when you turn your TV on and there's a Burger King or McDonald's TV ad, that came from a byproduct of all the franchisees contributing a small percentage so that everybody can benefit on a large scale.
-And that has to be powerful. I mean I don't know anybody who doesn't know what a Subway is. It has to be powerful, right?
-Well, take a look at it from a brand that's not on national TV. There's not a brand name that's highly recognizable. And you're just growing a brand. In order for everybody to contribute so that everybody can benefit, we call it the rising tide raises all ships.
[SHIP BELLS RING]
It may not be on TV or even radio yet, but the ways that franchise owner will invest that to get brand awareness and to bring potential clients or customers to your business is very beneficial.
-Now, we're moving on to the fabulous fee structure number four. And I don't even know if this is necessarily a fee. I might even be misclassifying it. But it's kind of like the fourth thing that you're going to have to pay a lot of times if you own a franchise. There is this advertising commitment.
And this is the amount of money that the franchisor requires a franchisee to spend on local market advertising for the business. As I was reading some FDDs from different franchises, I discovered that a lot of them say you have to spend $2,000 a month on some kind of advertising. Or they put a minimum. Why would a franchisor impose a minimum amount of advertising that I have to spend as a franchisee?
-Great question. The reason they do that is because they know from the success of their business model what it takes in order to deliver the type of business. So if I'm projecting to do $300,000 in volume, the franchisor knows what you need to invest in ahead of that each month in order to have that many customers or clients come to that business to achieve the $300,000.
So they want franchisees to understand that marketing, and advertising, and promoting that business is the foundation of any future success. And they want them to be clear that is not highly recommended or negotiable. This is the basis that you're going to commit to grow that business.
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