Royalty in Franchise Your Business – The Power of Royalties

by Charles White | Articles
4 minutes
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There are so many great benefits to a business owner when you franchise your business model. Opening up access to capital through franchisee’s investment, inviting dedicated owner-operators into your brand, scaling your brand’s presence exponentially, and increasing the valuation of your business to the tune of 15 to 20 times earnings valuations all are very exciting elements that come with a well-executed franchise development model.

It’s the Royalty Model that really makes franchising shine though, none of these positive elements compares to the excitement around the royalty model that franchising offers the business owner.

Royalties may not seem like much at first glance as they typically are 5-10% of Gross Sales collected by the Franchisor for the continued right to use the brand and the intellectual property.  Royalty fees are collected monthly in most service franchise offerings and weekly for most retail or food-based franchise systems.

The Royalty fee is paid by the Franchisee to the Franchisor for rights to the brand and business model and constitutes the primary compensation for most Franchisors.  They are the definition of a residual, compounding revenue model, and much like Dividends paid from cash flow-producing stocks, they are incredibly powerful cash flow-producing machines when a franchise system is working at full speed.

Let’s walk through some basic numbers to illustrate the power of the royalty fee model as a franchise system expands even at the early stages of growth.  First, let’s assume the business “unit” generates $750,000 in annual revenues and the Franchisor collects an 8% Royalty on Gross Sales.  This equates to $60,000 in annual Royalty Fees paid to the Franchisor. 

If you expand the term of the franchise agreement to ten years, this single Franchisee will produce $600,000 in Royalties for the first term of that franchise engagement. 

Now, let’s assume we sell 10 franchise units per year over a ten-year time period as the franchise model picks up momentum and scales into new markets:

  • 10 Franchises Per year
  • 8% Royalty Fee
  • $750,000 Average Unit Sales Volume
  • 10-Year Time Period

As the Franchisor in this model, the first year of Royalty Revenue is $600,000 with the ten units open. In year two, that number increases to $1,200,000, and in Year three to $1,800,000, bye Year ten, the model is producing $6,000,000 in annual Royalty Revenue, and in total during the ten years has produced $33,000,000 in Royalty Revenue.

The opportunity in franchising comes from replicating success, not just selling units and the Royalty model here showcases how successful operating units create much more financial opportunity for the Franchisor than just the fees collected upfront for selling the franchise unit.

To further this point, the valuation of franchise systems is largely based on the residual revenue, not the transactional upfront revenue generated through Franchise Fees. Many businesses franchise their company in order to one day achieve an exit and franchising absolutely creates that possibility with franchise brands consistently capturing enormous valuation ratios up to 25 X Earnings.

The majority of this valuation comes from the Royalty model as it is the highest margin revenue a franchise system will generate pushing more profit to the bottom line and having the most consistent, repeatable revenue structure.

Think about it, if you were buying a business, what would you rather purchase, one-time fees which are reliant on a transaction or monthly residuals which are collected through auto-debited accounts tied to POS systems in the franchised stores?

The Power of the Franchise Royalty Model is real, focus on what will drive growth in Royalties and your franchise system will win along with the franchisees who have committed themselves to your brand.

For more information on how to Franchise Your Business, contact us.

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