Making Money as a Franchisor: Charging Fees for Services

This blog previously discussed the common ways a franchisor makes money.  As we noted, almost all franchisors charge the following fees:

• An initial franchise fee;
• A periodic (weekly or monthly) royalty;
• A development fee or territory fee; and
• A periodic advertising fee.

We also began discussing less-common ways a franchisor makes money.  These were:

• Charging “Buildout Fees”: fees for developing a franchisee’s site;
• Charging “Rental Fees”: fees for developing a turnkey business and leasing it to the franchisee; and
• Forming an affiliated company to sell goods and services to franchisees, for a profit.

A fourth way is charging fees for services the franchisor provides to the franchisee.  Franchisors usually provide franchisees with services that both parties consider “covered” by the royalty the franchisor charges.  The franchisor usually provides these services in a group setting; e.g., at a convention, at a regional meeting, or electronically.  All franchisees (or all franchisees in a given region, or all franchisees with a given level of experience) are usually given the opportunity to participate.  The services usually include group assistance in different aspects of operating a franchise: for example, planning, marketing, managing, and new products or services the franchisor intends to introduce into the marketplace.

A franchisor may be well within its rights to charge for other services it provides.  These services are usually provided on an individual basis or to new franchisees as a small group.  Primary among these is charging a training fee.  Although many franchisors include initial training to be covered by the initial franchise fee, that is not necessarily the best way to charge training fees.  If training fees are included in the initial franchise fee, the franchisee will usually amortize the fees.  However, if the franchisor charges a separate training fee, the franchisee may usually expense the fee.

Other services usually include specialized training in matters like staffing, generating leads and referrals, optimizing and organizing computerized resources, conducting specialized marketing campaigns, and controlling operation of the franchised business.

If the franchise system is large, the franchisor may want to:

1. Form an affiliated company (the “Franchisee Operations Company”) to provide the services;
2. Have the Franchisee Operations Company hire its own specialized personnel and engage the services of independent contractors (e.g., personnel specialists, marketing specialists, business intelligence specialists, and accountants);
3. Have the Franchisee Operations Company actually provide the services; and
4. Have the Franchisee Operations Company collect the revenues.

Forming a separate company allows the franchisor to:

1. Protect its other companies from liability;
2. Pledge or sell equity in the Franchisee Operations Company without affecting its other companies;
3. Tailor its business expenses for tax purposes; and
4. Calculate a markup that would be reasonable to charge for services.

We previously mentioned forming a Supply Company to sell products and services to franchisees.  As in the case of the Supply Company, there is no cap on the markup the Franchisee Operations Company may charge for providing services.  However:

1. The markup must be reasonable. It must be low enough that: (i) the franchisee may still make a fair rate of return on its franchised business; (ii) the markup does not place undue strain on the franchisor-franchisee relationship; and (iii) the markup does not breach the implied covenant of good faith and fair dealing present in all contracts.
2. The franchisor must disclose in its Franchise Disclosure Document the amounts the Franchisee Operations Company receives.