Australia: What is the ongoing franchise fee and why is it so important?

As a franchisee, there are a few types of fees that you may and will most likely be required to pay when you enter into a franchise agreement.

These fees vary from franchise to franchise and can include but are not limited to: initial franchise fees, fit-out and equipment costs, training costs, inventory costs, marketing and promotional fees, and other costs such as legal spend, insurances and licenses.

However, one of the most important payments a franchisee will make is the ongoing franchise fee, typically known as the royalty fee.

The ongoing franchise fee is paid to the franchisor so that the franchisee can trade under the franchisor's name, use the franchisor's trade secrets (such as menus or recipes) and be a part of the franchise system generally.

Ongoing franchise fees vary from franchise to franchise and can be charged as a percentage of total turnover of the franchised business or a fixed amount for the length of the franchise agreement.

When might you be in default of ongoing franchise fees?

It can be difficult to stay on top of all of the payments you need to make to the franchisor, particularly in the early stages of the business.

Franchisees often struggle to pay their franchise fees for the following reasons:

Sales decline

The volume of sales made in your business is certainly going to affect your ability to make payments to the franchisor. Sales may be down for many reasons such as seasons, holiday periods, shopping centre refurbishments or competitors opening stores nearby.

The business hasn't taken off yet

If you're a new franchisee, in a new store, it will take some time for customers to get to know you. If you've purchased the business from someone else, it also may take time for word to circulate that a new owner is in business.

Bad financial hygiene

This is common for first time business owners operating their franchise. Bad financial hygiene can be as simple as over ordering stock, sourcing expensive goods when cheaper alternatives are available or simply over staffing.

I can't make this ongoing franchise fee payment, what do I do now?

There are a few options available to you if you are unable to pay your ongoing franchise fee. These include:

  1. Talking to your franchisor

Too often franchisees will bury their head in the sand hoping the franchisor won't notice. Franchisors always notice when payments aren't made.

Instead, I suggest contacting your franchisor as early as possible to discuss the situation and to tell them why payments can't be made at this time.

If you are struggling with the business, this is also a good time to discuss receiving additional training or support from the franchisor who can guide you with strategies that may help you to get back on your feet.

  1. Request a payment plan

While you may not be able to pay the entire outstanding franchise fee, it may be possible to come to an arrangement to pay by instalment or at a reduced rate. Make sure any suggested payment plan is suitable for your needs.

  1. Request an extension of time

As with the payment plan, you can nominate a timeframe in which it proposes to pay back any outstanding fees.

If you are a franchisee in default of payments, it is important you use one of the above options as it demonstrates you are acting in good faith in trying to address the problem. In this instance, the franchisor is more likely to be accommodating where they can see the franchisee is trying to meet obligations under the franchise agreement.

What is the worst that can happen?

Failing to address the problem can result in a number of outcomes such as:

  1. Being issued a notice of breach for the failing to meet the terms of the franchise agreement. Any breach notice issued to you should specify the amount outstanding, when the payment is due and will generally reserve the franchisor's right to terminate the franchise agreement if the breach remain outstanding.
  2. Franchise termination. The payment of ongoing franchise fees is often an essential condition of the franchise agreement and most, if not all, agreements will outline the franchisor's right to terminate the contract in the case of default. If the franchise is terminated, you will be left without a business.
  3. Litigation. If the ongoing franchise fee remains outstanding, the franchisor may, subject to any dispute resolution provisions under the franchise agreement, take you to court to recover the outstanding debt. Litigation is typically very expensive and time consuming and should be avoided where possible.

How do you avoid this?

Do your research

When deciding whether to buy a franchised business, a potential franchisee should carry out due diligence on the franchise. This should involve both a legal and a financial health check of the business.

I suggest considering what the 'worst case' financial obligations look like and deciding whether or not you would be in a position to take on the business if the 'worst case' scenario happened.

Reduce your risk

It is difficult to forecast what challenges you will face. As such, in spite of your best intentions, you may find yourself in an expected situation and unable to comply with your obligations under the franchise agreement.

A franchisee who is willing to address the issues early and communicate with their franchisor is more likely to remain in business.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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