How Much Money Does a Franchise Make?
How Much Money Does a Franchise Make?
Although franchising is a large and expansive market segment, there are a relatively small percentage of business owners who have been involved in franchising from the franchisor’s side of the relationship. In many cases, we are around franchising all the time almost every day as a consumer, even in many cases as a franchise owner. But when you franchise your business and start a franchise platform, it is a unique perspective and a unique financial model. My name is Chris Conner, I started Franchise Marketing Systems in 2009 and had worked in the franchise industry since 2002 doing just this type of work, helping brands transition into franchising and roll out new franchise systems. Part of my work is helping business owners understand how franchising works and what the financial model could potentially look like for them should franchising become part of their expansion plans.
First things first, how does a Franchise system make money and what are the revenue sources?
1. Initial Franchise Fee – a franchisee pays the franchisor a fee to have access and rights, essentially to “Rent” the use of the brand and the business system. This fee is paid at the signing of the Franchise Agreement and ranges from $15,000 to $50,000. The Franchisor in return for this fee provides training, support and the intellectual property they have developed.
2. Royalty – The primary revenue driver for most franchise systems is the royalty, which is an ongoing fee for the continued right to use the name and franchise system. Royalties are most often a percentage of top-line revenues and range from 4% – 12% of Gross Sales. Royalties are usually paid to the Franchisor monthly for service models and weekly for retail models.
3. Product or Service Sales – The Franchisor has the right to require the Franchisee to purchase products or services from them as part of the ongoing relationship. This means that you can require franchisees to purchase a product or service that you provide at a profit. If you do it right, you are selling the product or the service to the franchisee at a price point where the franchisee is still be profitable and realize the margins they need to when “reselling” the product the end consumer.
4. Additional Services – Many franchises also charge fees for additional services and support models, the franchisee may have the option to use these, but the franchisor defines the fee structure upfront. Should the franchisee choose to use these services, they will pay the associated fees and costs.
Let’s look at some basic numbers:
1. Assume you sell 5 Franchises Per year for a 5 Year Time Period.
2. Assume your average Franchise Location generates $500,000 in annual sales.
3. Now Assume you charge a 5% Royalty on Gross Sales, Collect a 5% Rebate on Required Franchisee Purchases and a $35,000 Franchise Fee for each unit.
25 Franchises (5 per year for 5 years) = $875,000 in Initial Franchise Fees Collected.
At $500,000 in annual Gross Sales per Unit, each Franchise will be paying back Royalties and Rebates on Product Purchases of 10% equal to $50,000 per year.
Total Royalties and Rebates collected in 5 years = $3,750,000.
Total Revenue on Franchise Model in Five Years = $4,625,000
*And what is even more compelling about the ongoing revenue model of franchising is that the franchise Agreements are 10-20 Years in Length, so this ongoing residual franchise revenue continues for the life of those agreements. This means that EACH of these franchise agreements are worth $1,000,000. (20 Years of $50,000 in rebates and royalties).
Second, let’s look at the value of a business and how franchising impacts the overall asset worth. The problem with most of our businesses is that they are incredibly dependent on US, the person who is running the day to day operations. If you are operating all company owned locations and business, the value of the business will typically be 1.5 – 3 X one year of profit in the business or EBITDA (Earnings Before Income Taxes and Depreciation of Assets). So if your business is generating $100,000 in annual net profits, your business should be worth $150,000 to $300,000. Franchise companies are generally offered much higher multiples when valued, Franchise Marketing Systems has had several clients sell for as much as 24 X EBITDA! Most likely, 10-15 X EBITDA is more typical, but the valuation is much higher once the business provides that others can be successful operating the business and there is essentially a proven system in place. Big Picture, your business becomes worth a LOT more if you are able to successfully franchise the business model and have franchisees take on the operating responsibilities for their own businesses. By proving the success of the business is not dependent solely on yourself, your business is worth more to a potential buyer.
There are many reasons to franchise your business, the financial model, while certainly an exciting component of why businesses franchise, is only one of them. For more information on how to franchise your business and whether to franchise your business, contact Chris Conner with Franchise Marketing Systems:
Franchise Marketing Systems