Understanding the Item 6Item Six requires franchisees to disclose “recurring or occasional fees associated with operating a franchise” (section 436.5[f]). This is any ongoing money you pay to the franchisor or an affiliate thereof. If you are considering buying a franchise, this is one of the most important items. Item 6 in an FDD may seem very straight-forward, but it requires significant study and investigation to fully understand how it may impact your business. Though the $200/month technology fee may seem like nothing compared to a $25,000 franchise fee, that tech fee can cost you basically the same ($24,000) over the course of a 10 year franchise agreement.

Some franchisors have a 4-5 line item Item 6, whereas others may take up 3 or 4 pages or more. It is imperative that you understand EVERY fee on Item 6, its likelihood of affecting you, and also make sure that it is in your business plan. Here are some things you should consider as you try to understand the Item Six of the FDD:

Royalty

The royalty is pretty basic, but you need to check in the remarks/notes section, the footnotes, and the agreement itself to see when/if it can change. For a business that does $500,000 a year, a change of just 1% can make a difference of $50,000 over a ten-year term, so understanding under what circumstances that this can change is very important.  This, in addition to franchise fees, is the primary way your franchisor is able to pay their bills and staff the corporate office.

National Marketing

Most franchisors either have a National Marketing fund or have one reserved in the agreement, whereby they can instate one, either when the brand reaches a certain strength or when they decide, upon notice.  Typically, this is between 1%-2% of gross. Talk to other franchisees about this, and see if they are getting a benefit from the fund. If not, attempt to negotiate it out of the agreement, or wait for 12-24 months before it starts. Some franchisors will bend on this, many will not, but it is definitely worth understanding.  Keep in mind that the most successful franchisees pay a disproportionate amount, so also consider negotiating a cap on this. Understand that some of these funds may also be earmarked for corporate staff; any employee in the marketing process could be paid for by the marketing fund.

Regional Marketing

This is a co-op type fund that franchisors typically reserve in their document. The idea is that, if a certain market has a high concentration of franchisees, the franchisor can mandate that they use some or all of their local marketing (see below), taking advantage of economies of scale for the betterment of the brand and the region. The only time to be concerned about this fee is if it is in addition to, rather than in lieu of, your local marketing.

Local Marketing

This is the amount of money that a franchisor requires that you spend in your market to promote the brand. Make sure that these numbers are in your business plan, and really understand what they may mean to you. As you reach maturity, you may find that spending 2-3% of your gross revenue each year on marketing no longer makes sense, so consider trying to negotiate a cap or a endpoint to this.

Technology

This is a fee you will often see for access to the franchisors Point of Sale, website, e-commerce, and also to fund research and development. The important things to look at are does the fee cover all major technology needs, and under what circumstances can it change. Talk to other franchisees and get a real feel for the technology provided.

 

Business Generation

Some franchisors, specifically in service-based industries, will charge you an additional percentage on business that they generate for you through their national advertising efforts. The key here is do you have to accept the business that they generate, and if so is the business profitable even with this extra fee? This can be a business killer, so be very careful in understanding what this could mean to your bottom line if 10%, 20%, or even more than 50% of your business is coming from your franchisor.

Training

Most franchisors include some sort of training in their franchise fee, but there is often a cap on how many people per franchisee can attend. It is important to look at this in comparison to who the franchisor requires to attend. As an example, if you are planning on hiring a manager, the franchisor may require that the manager attend training. If the franchisor only provides one free training slot, but both you and your manager are required to attend, you may be out extra money.

Conference

Many franchisors have an annual conference. Some don’t charge for the conference, others charge as much as $5,000 or more. Understand where the conference is, who is required to attend, what the fees are, and if they can change.

Transfer

Transferring your franchise is likely part of your exit strategy. Understand what the costs to transfer are, and make sure this is factored in.

 

There are many other fees that you will see in an FDD, including renewal, late fees, onsite training fees, etc. This list is not exhaustive, but it covers the most popular fees that are likely to affect your day to day business and your profitability.  Make sure that you understand every fee listed. If you don’t, ask. Ask the franchisor and ask the franchisees that you speak to during your validation process.