The fundamental aspects of the franchise agreement


Initial and Ongoing Franchise Fees

There are several different types of payments generally owing under a typical franchise agreement. Most franchise agreements require the payment of a one-time initial franchise fee and an ongoing royalty fee. In addition, many franchise systems require franchisee to contribute to a marketing fund by way of an ongoing advertising fee. Each of these franchisee fees is discussed in greater detail below.

Initial Franchise Fee

The initial franchise fee represents the fee payable by the franchisee for the right, licence and privilege to operate the franchised business using the franchisor’s system and trade-marks. The initial franchisee fee is usually due upon execution of the franchise agreement and is typically acknowledged to be fully earned and non-refundable. In certain circumstances, some franchisors may refund the initial franchise fee. For example, where a franchisee has failed to demonstrate the qualities and abilities which the franchisor deems necessary for the successful operation as a franchisee or if the franchisee fails to complete the initial training program, the franchisor may reserve the right to terminate the franchise agreement and, in the event of such termination, refund the initial franchisee fee, less the franchisor’s reasonable administrative, supervisory, accounting, training and legal costs.

Where the franchisor requires a deposit fee in order to process a prospective franchisee’s application, the deposit is usually deducted from the initial franchise fee. The initial franchise fee is distinguished from training fees, construction or development costs and other costs associated with opening the franchised business.

The amount of the initial franchise fee will vary greatly depending on the nature of the franchised business. For example, a small home-based franchisee may be required to pay an initial fee of $1,000, while a franchisee entering into an agreement with a mature, wellestablished restaurant or hotel franchise system may be required to pay an initial fee of $75,000 or more.

B. Royalty Fees

The majority of franchise systems will require franchisees to pay an ongoing periodic royalty fee. The royalty fee is the primary vehicle through which franchisors generate ongoing revenues from franchisees. These fees are usually expressed as a percentage of “gross sales” and are typically payable on a weekly or monthly basis. For example, a typical royalty fee for an established restaurant chain may be in the range of four to six percent of the franchisee’s gross sales. It is increasingly common for the franchisor to require weekly payment of royalty fees by way of electronic funds transfer from the franchisee’s bank account.

Since the royalty fee is typically based on gross sales, “gross sales” is one of the most important definitions under any franchise agreement. The parties should pay careful attention to what is and is not included in such definition. A sample definition of “gross sales” is provided below.

“Gross Sales” means the aggregate of all sales and other income of Franchisee from whatever source derived, whether or not collected by Franchisee and whether for cheque, cash, credit or otherwise, arising out of, in connection with or relating to the Franchised Business including, without limitation, all proceeds from any business interruption insurance but excluding all refunds and discounts made in good faith to arm’s length customers, any sales, goods and services and equivalent taxes which are collected by Franchisee for or on behalf of any governmental or other public body and actually remitted to such body, and the value of any coupon, voucher or other allowance authorized by Franchisor and issued or granted to arm’s length customers of the Franchised Business which is received or credited by Franchisee in full or partial satisfaction of the price of any item or service offered in connection with the Franchised Business;

C. Advertising Fees

In addition to the requirement to pay royalty fees, franchisees are often required to pay an ongoing advertising or marketing fund fee. Advertising fees are also typically based on a percentage of gross sales, albeit usually a smaller percentage than the royalty fee. The creation and use of an advertising fund is discussed in greater detail below.