Making money as a franchisor: Development Fees

This post is the fourth installment of the post dated March 17, 2015, titled “How Do I Make Money as a Franchisor?”  This installment will treat Development Fees, sometimes known as “Territory Fees.”

Most franchisees want to operate more than one outlet, and most franchisors want them to do so.  There are many advantages to multi-unit franchising.  One of the principal advantages is cost: both parties get the benefits of a reduced learning curve (and hence reduced costs) for each outlet the franchisee opens.  As one example, one of my clients has a franchisee with over 40 restaurants.  The franchisee has its own finance department, construction department, training department, and operations specialists.  It is a well-oiled machine.  The franchisor’s pre-opening costs are close to nil.

Franchisors generally offer incentives to encourage multi-unit franchising.  For example, the franchisor usually grants a “development territory” where the franchisee may develop its second, third, and subsequent outlets.  If the development territory is exclusive, the franchisor is taking the territory off the market for a period of time.  Because the franchisor is taking the territory off the market, the franchisor is forbearing its right to receive initial franchise fees, royalties, and other amounts that it would ordinarily earn by enfranchising others.  The franchisor has the right to be compensated for this; hence, it will usually charge a Development Fee.

Development Fees usually range from $5,000 to $20,000 per additional outlet the franchisee purchases the right to develop.  The amount of the per-outlet Development Fee depends on factors that include:

• The size of the territory.  As a general rule, the more additional outlets the franchisee purchases the right to develop, the larger the territory and the higher the Development Fee.
• How long the franchisor will hold the territory off the market.  This usually depends on the time it takes the franchisee to secure sites, the costs to develop an outlet, the availability of financing, and other factors.
• The value of the territory to the franchise system.  The Development Fee for outlets in major cities like New York, Los Angeles, Chicago, and metro Atlanta would probably be significantly higher than the Development Fees for sparsely-populated areas.
• What the market will bear.

Is the Development Fee a big money maker for franchisors?  If the franchisor emphasizes multi-unit development, yes.  There are additional benefits; as one example, Development Fees are usually paid when the franchisee signs the franchise agreement, so they are earned and recognized immediately.  We will work with you to determine the amount of your Development Fee, to help ensure that you maximize your returns.