One of the questions we receive most often from entrepreneurs seeking to franchise their business is how to price their franchise. Most franchisors receive an initial franchise fee, and an ongoing royalty, but how do you determine the amount of these fees? There is no easy answer to this question; and it is more of an art than a science.

Start Low

For the initial fee, many startup franchisors make the mistake of setting too high a fee. They see that a mature franchisor in their space charges $35,000 for an initial franchise fee, so they decide to “discount” their fee to $30,000. However, what do franchisees get for this fee? How much does it cost you to provide initial services to your franchisees? Our recommendation to our clients is that when they first start franchising, they set their initial franchise fees on the low side. It has always been my feeling that if I could put 100 people in a room, and instantly have them all sold, trained and open for business, with no cost to me, I would give away the initial franchise fee. The point is that you will not make money on your initial fee, at least not in the early years. Rather, you want to find good prospects who will open your first franchises, be able to vouch for the concept, and pay you royalties over the years. If you can “break even” on the initial fee, and get a good franchisee open in a prime location, you have done well. If that means pricing the initial fee too low, you are leaving very little money on the table, compared to the ongoing royalties you will receive over the life of the franchise, and you are creating “raving fans” for your brand. Perhaps more importantly, it is more palatable to your early franchisees to learn that they paid less than franchisees pay today, than to learn that they paid more and you are now discounting the product.

Royalties

In terms of your ongoing royalty, you need to have a high enough fee to operate your business and earn a reasonable profit. At the same time, your franchisees need to be able to pay your fee, and earn a profit from their business. The rule of thumb we give to our clients is that if at the end of the day your royalties equal between 1/4 and 1/3 of your franchisees’ bottom lines, meaning that for every royalty dollar that franchisees pay you, they will be able to pay themselves two dollars or three dollars – you will have happy franchisees. That is not to say that your royalties should be set as a percentage of a franchisee’s profits, but you should do some financial modeling, determine a typical bottom line for a franchisee, and set your royalty based on a percentage of sales that will net you 1/4 to 1/3 of their bottom line. If that gives you the profit you need, you have a good business model, but if you need to take as much or more from each franchised outlet than the franchisee typically pays himself, the model will not stand the test of time.

For guidance on what other franchisors charge, check out the January issue of Entrepreneur Magazine. Every year, they have a listing of more than 1,000 franchises, showing the initial fees, ongoing royalties and advertising/marketing fees those franchisors charge to their franchisees. This will not tell you what franchisees receive for their money, and it will not necessarily include all fees the franchisor collects, but it will give you an idea of what others in your space are charging.