With very few exceptions all franchise agreements require new franchisees to pay an initial fee to the franchisor on entering into the franchise agreement. The initial fee reimburses the franchisor the substantial costs that the franchisor would have incurred in recruiting the franchisee as well as paying for the initial training, stock, equipment, vehicles, uniforms and performing all of the other initial obligations on the franchisor. Sometimes this initial fee is broken down into two fees – a licence fee which relates to the rights granted to a franchisee to operate the franchise and a package fee which relates to the elements that a franchisor will provide or perform as part of its initial obligations. It may be that in relation to some of these elements an incoming franchisee will be able to set off the cost against its profits to calculate its tax liability, but each franchisee should obtain its own tax advice.
In addition to the initial fee franchisees will, of course, have to have sufficient cash to fund their business until it is profitable. Very few, if any businesses become cash positive immediately and so there will be a period when franchisees will need to fund the business. As part of the process of taking up a franchise, franchisees will also obtain professional advice, from accountants and lawyers and may, in addition, have to incur the costs of items which they are required to have for their franchise business but which are not provided by the franchisor – often, for instance, franchisees are required to have computer equipment which the franchisor does not supply.
Written by: John Pratt
Partner, Hamilton Pratt