How does a franchisor earn an income from its franchisees?

Usually, a franchisee will be required to pay an initial fee in full on entering into the franchise agreement. This is payable in respect of the initial range of services the franchisor provides to the franchisee, as well as a charge for the value of joining the franchise system.

In addition, the franchisee may be expected to pay for an initial package of equipment and other items required to set up the business. The franchisor may have bought the equipment from suppliers at a discount below the market price. Franchisors may charge a mark-up to cover the cost of putting the package together and make a contribution to its overheads.

In order to finance the continuing services and back-up provided to franchisees, the franchisor has to secure a regular flow of income. This is normally achieved by charging what are usually called management services fees or royalties on continuing fees.

Most franchisors charge a straight percentage fee based on the gross revenues of the franchisee.

If you have to buy all or some of your products from the franchisor, you need to enquire whether the franchisor will make a profit on this transaction. Occasionally, the franchise agreement will not provide for the payment of a separate management services fee or other continuing fee, as the mark-up on the sale of goods will instead be the source of profit for the franchisor.

The franchisor may decide that where it takes a lease of premises and sub-lets to its franchisees, that it charges a higher rent to the franchisee, thereby earning a profit rental for itself.

Some franchisors add on a fixed sum or certain percentage of the annual rent payable to cover their costs in administering the sub-leases.

Shelley Nadler is a legal director in Bird & Bird’s international franchising team and has many years’ experience of advising on all aspects of franchising.