How does a franchisor use the initial franchise fee?

Franchisors charge an initial fee which is sometimes split between a “licence fee” for the rights to operate as a franchise and a “package fee” for equipment, stock and other items supplied by the franchisor. Franchisees need to make sure when they are comparing the initial fees of various franchisors that they include all initial payments.
The initial fee as its name suggests is paid almost always on execution of the franchise agreement and before training has been provided. It can be a substantial amount. The purpose of the initial fee is to reimburse the franchisor the substantial cost it would have incurred in recruiting the franchisee, providing initial training and supplying the elements forming part of the initial package. Franchisees should ask franchisors for a breakdown of the initial fee because this may be necessary to obtain favourable tax treatments for the payment of the initial fee. Generally, capital expenditure is dealt with much less favourably than trading expenditure.
There is a debate as to the extent to which it is in order for franchisors to include a profit element in the initial fee. This writer’s view is that it is only with well established franchises with a proven successful track record, that an element of profit can be included. In other cases franchisors are entitled to a contribution to the costs that they have incurred in establishing their franchise business but not a profit element.

Written by: John Pratt

Partner, Hamilton Pratt