This article by Tom Spadea was featured in the March 2023 issue of Franchise Dictionary Magazine.
Should My Corporate Stores Pay Royalties?
Absolutely! If you make $100 in profit, that $100 on the open market is worth the multiple of the earnings in the business it is generated. If you pay that $100 in royalties to the franchisor, that $100 becomes an expense to your operating unit and profit to the franchisor.
A typical small business is worth about three times earnings while a franchisor could be worth 10 to 15 times earnings or more. So you just took $100, that was worth $300 in the operating unit, passed it into the franchisor, and now it’s worth $1,000 to $1,500. This starts establishing, from day one, that every dollar in revenue in the franchisor is your highest and best dollar. And you don’t hurt your tax minimization strategy, as you have offsetting expenses in the corporate store.
This is also one of the best ways to fund your franchisor. If you’re doing a million dollars in sales and charging a 6% royalty, you now have $60,000 of cash flow into your franchisor, increasing its health and strengthening its balance sheet. It also tells the story to your franchisees and candidates that the business can support being part of a franchise system. If you can’t afford to pay royalties out of your corporate store, maybe you have deeper issues you need to solve.
Your financials are important, and perhaps one of the top items scrutinized by potential franchisees. It is a very good barometer of the health of any business. It is also important to note that the books of a franchisor should not be run like the typical small business with a goal of tax avoidance. Don’t load up the franchisor with extra cell phones, club memberships and other extraneous expenses that are not pertinent to running the franchisor business. That typical mindset held by most small businesses and small-business accountants can be detrimental to your growth as a franchisor. Run those expenses through your company location if you have to.
The profits in the franchisor entity are what really drive wealth creation and are the ultimate objective scorecard that a future buyer will assess.
To see all of Tom’s featured articles on The Franchise Dictionary Magazine, visit this page.