What’s Up With That Upfront Fee?
In the world of franchising, upfront fees are a common and often crucial element of the franchise agreement. Understanding the purpose and fairness of these fees is essential for both franchisees and franchisors. This article features the best practice on upfront fees and provides insights into their significance and ethical managemenet within the franchising industry.
What is an Upfront Fee?
An upfront fee, also known as a joining fee or initial fee, is a fixed amount usually payable upon signing the franchise agreement. In exchange, the franchisee gains the rights to use the franchise’s name, logo, and business systems.
Why is there an Upfront Fee?
There are twon main reasons why franchisees need to pay an upfront fee:
1.Development costs: This fee assists the franchisor with the development of the franchise business, including:
- Site selection
- Lease negotiation
- Business planning
- Securing finance
- Outlet design and build
- Staff recruitment and training
- Pre-launch local marketing
2. Remuneration for Business Know-How: The fee compensates the franchisor for the development of the business concept and secures the rights to operate the franchise in a specific territory.
What is a Fair Upfront Fee?
There are various considerations to decide what a fair upfront fee would be, this incudes the following:
- Market Comparison: Compare what other franchisors charge to remain competitive.
- Return on Investment: The capital invested, including the upfront fee, should be recovered through profits within 3 to 4 years, after the franchisee receives a market related salary.
- Development Costs: The fee should reflect the Franchisor’s development costs, amortised over the projected total number of franchises planned.
- Direct Costs: The fee should recoup actual direct costs incurred as outlined above.
Noteworthy Points
It is interesting to note that an upfront fee may be disproportionate and vary, in that the fee may not be the same for all franchisees.
- Variable Fees: Upfront fees may vary depending on the location. Prime areas, which are more profitable, may justify higher fees compared to secondary areas.
Unethical and Unlawful Practices
- Delayed Territory Awarding: Franchisors should not keep an upfront fee for an extended period without awarding a territory and specific site. Delays are lack of communication for 5 or 6 months after receiveing the fee are considered unethical.
- Primary Income Source: Franchisors should not rely on upfront fees as their main source of income to stay liquid or solvent.
Impact of the Consumer Protection Act (CPA)
Section 7(2) of the Consumer Protection Act No.68 of 2008 (CPA) states that “a franchisee nay cancel a franchise agreement without cost or penalty within 10 business days after signing such agreement, by giving written notice to the franchisor.”
Implications
- Cooling-Off Period: An upfront fee paid into a trust or a seperate bank account is fully refundable if the franchisee cancels within the cooling-off period. No penalities or cost recoveries can be imposed.
- Post Cooling-Off Period: If a franchisee cancels after the cooling-off period, the franchisor can deduct costs incurred. For instance:
- Upfront fee: R150 000
- Costs incurred by franchisor: R40 000
- Refund to franchisee: R110 000
Conclusion
Upfront fees are a valid and neccessary component of franchising. Franchisees should ensure they are dealing with reputable franchisors to ensure these fees are managed ethically and transparently.
