​​What is a royalty? How does this payment affect the sale or choice of a franchise?

In the franchising industry, there are several basic terms that refer to the types of payments: lump sum payment, royalties, marketing (advertising) and service payments. If you have decided to scale your business using the franchise model or want to buy an existing franchise, you should clearly understand what these payments are. Today we will talk about royalties. After all, this is one of the most frequently used terms in franchising. 

The word “royalty” is of French origin and means “a tax paid to a monarch”. A more modern meaning is a monetary remuneration paid by a franchisee to a franchise owner (franchisor) for the right to use his brand, business model, business system, technology, reputation, etc. for his own commercial purposes.

Royalties refer to periodic mandatory payments, usually paid on a monthly or quarterly basis. It can be fixed or a percentage of income, very rarely of profit. The amount of the percentage varies from 1% to 10%, in some cases 20-30% and even more. The amount of royalties is important for every participant in the franchise business. For example, if the franchisor overestimates the royalty rate, it can negatively affect the attraction of potential partners. After all, in this case, the offer may not be economically viable for the franchisee. Therefore, in pursuit of its own profits, the franchisor needs to clearly analyze its own and partner business models, carefully assess the situation and offer partners terms of cooperation that will be beneficial for all parties.

For franchisees, the amount of royalties affects the profitability of their business. Therefore, when choosing a franchise, you should pay closer attention to all payments, especially the regular ones (sometimes they can be hidden). If the cooperation plan proposed by the franchisor causes concern, you should not rush into a decision, even if it is a well-known brand. Seek advice from business consultants and entrepreneurs you know. 

In other words, royalties are a payment for the right to operate under the franchisor’s brand and support of the affiliate business by the franchisor’s company.

It is worth noting that the franchisor independently sets a certain percentage of royalties. The amount and procedure of payment must be fixed in the terms of the franchise agreement (usually a Сommercial concession agreement).

It should be remembered that the higher the brand’s recognition and popularity, the more functions the franchisor takes over, the higher the royalty fee. In this case, the franchisor tries to cover its own expenses and insures itself against unscrupulous franchisees who are not interested in business development.

There are many offers on the franchise market when the franchisor offers to pay a minimum monthly payment. This option is perfect for new entrepreneurs. However, you should not choose a franchise based solely on the low royalty fee (the same applies to the lump sum payment). Consider all the terms of the agreement. To put it another way, if you want to save money on payments, you may encounter unscrupulous franchisors who are not interested in building and developing their own franchise network.

There are the following types of royalties::

• Payment of a certain percentage of gross income for a specific period of time;
• Fixed royalty — payment of a set amount of money for each franchise outlet;
• Percentage of the margin — used at different levels of margin on a product or service.

There is another type of royalty, so-called hidden royalties. For example, when the amount of royalties is included in the cost of the goods or services supplied to the franchisee.

The amount of royalties may depend on the following factors::

• Brand recognition and popularity
• Expenditures on salaries and incentives for the staff involved in the creation, development and support of the franchise network
• Current expenses for advertising activities, training, etc.
• The amount of expected monthly profit of the franchisee

There are franchises that do not require monthly payments. Usually, such conditions are declared by franchisors seeking to attract as many partners as possible in a short period of time. Later, as the business expands, the terms may change. 

Some franchisors offer a royalty vacation for a certain period. Be prepared that as soon as franchised outlets start to generate stable income, the franchisor may require you to pay royalties at a higher rate.

Have you thought about what amount of royalties will be the most acceptable for partners and profitable for your business? Do you need help choosing a franchise? FRANCHISE CAPITAL experts are ready to help. Trust your business only to true professionals!

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