Royalty fees are a vital component to any franchise business. In addition to initial startup fees, franchisees are required to pay an ongoing royalty fee to the franchisor, which is, to put it bluntly, how franchisors make money. When determining royalty fees, franchisors can choose from a number of royalty structures. As you choose the best royalty structure for your business, it’s important to ensure franchisees pay their fees on time and in the correct amount. Below, we’ve outlined some of the common franchise royalty structures and the considerations of each.
Fixed Royalty
This royalty is a fixed fee that is not affected by sales, transactions, or profits, making it the simplest royalty structure to administer. As the name implies, franchisees are required to pay a fixed fee each month. This assures the franchisor of a fixed return each month, while the franchisee receives the full benefit from increased sales.
The downfall to this royalty structure is that a franchisee may be required to pay a higher royalty than they can afford at certain times. This can cause the franchisee to delay payments or not submit them altogether.
Gross Sales Percentage
Under this royalty structure, franchisors charge a percentage of a franchisee’s gross sales, typically after making approved adjustments for taxes, returns, etc. However, these adjustments can make it easy for franchisees to take advantage. For example, franchisees may try to commit return fraud or tax fraud as a way to underreport gross sales and keep more money in their pocket.
When determining your gross sale percentage, you can choose from the following models:
Fixed Percentage
This is typically the simplest to administer, as the percentage never changes. In this setup, the franchisee will have to pay a set percentage of gross sales to the franchisor, regardless of the franchisee’s sales or income.
Increasing Percentage
Location is one of the most important factors that can impact a franchise business. As some franchise locations are more likely to ensure higher sales than others, the percentage of a franchisee’s gross sales is adjusted accordingly. This allows franchisors to charge higher royalty fees for, say, a Times Square location than a location in the rural Midwest.
Decreasing Percentage
This royalty structure has the franchisee paying a lower percentage of gross sales as the total gross sales increase. The rationale is that by rewarding high-performers with lower royalty fees, franchisees will have more incentive to report total gross sales accurately.
Split Profit
In this royalty structure, the total profit of a franchisee is split at an agreed percentage, such as 20/80, between the franchisor and the franchisee. As is similar to the gross sales royalty structure, franchisees may try to take advantage of this payment model. Be wary of franchisees finding creative ways to make their profits look smaller than they actually are by falsely allocating funds to other projects and not counting them as profit.
Percentage per Transaction
As the name implies, franchisors earn an agreed-upon percentage for every transaction made in this type of royalty structure. This type of royalty structure is most commonly used in the hospitality or automobile industry but can be applied to virtually any type of franchise. Often, franchisors will use point-of-sale (POS) systems that automatically do the calculations for better royalty assurance.
Franchise and Royalty Assurance Services
No matter which type of royalty payment structure you choose, franchisors need to ensure royalty fees are being paid on time and in the correct amount. HS Brands specializes in providing proven franchise and royalty assurance services designed to identify and resolve franchise issues related to underreporting and brand standards compliance. Offering a national and global team, we’ll work with you to help keep your brand and your profits protected.
In addition to royalty and franchise assurance, HS Brands offers mystery shopping and loss prevention services to provide holistic assessment and verification of your expectations. Contact HS Brands today to request a consultation.
