Franchise Fees—How High Can They Go?

 

Let’s walk down memory lane. When I first became involved with representing 7-Eleven franchisees some 40 years or so ago, franchise fees for a store were a mere nuisance. I recall $1,500, but franchisees in the system before my time remember fess of $1. That was when Southland (remember Southland Corp.?) could not even give away stores and before more recent times when hopeful prospects literally line up to grab every decent store that comes on the market—new or existing.

Fast forward 40 years—what a difference! Not only have franchise fees dramatically increased but, starting with the 2012 agreement there is no longer a formula from which a franchisee could determine what he or she would be required to pay for a multiple or what a prospective goodwill purchaser would need to pay to SEI in addition to the goodwill price.

As recently as 2004, with respect to existing stores, it was an easy process. For stores having a gross profit of $200,000 to $250,000 the fee was 5 percent of the gross profit for the prior 12 months, for stores having a gross profit of $250,000 to $300,000 the fee was 10 percent of the gross profit, while the fee for most of the stores (those having a gross profit over $300,000) was 15 percent of the gross profit for the prior 12 months. As to the new stores, the same formula applied, but the gross profit was based upon the average gross profit for the prior calendar year for a designated group of stores in the same market.

That was the good old days. The 2006 agreement brought to us more dollar categories to which a franchise fee percentage would be applied, with higher volume stores having a gross profit of $450,000 to $800,000 requiring a franchise fee of 25 percent of the prior 12 month gross profit, and those stores with a gross profit of over $800,000 jumping to a cap of 30 percent. This was a huge change. For instance, prior to 2006, the franchise fee for a store having a gross profit of $800,000 was $120,000, becoming $240,000 thereafter starting in 2006.

That formula more or less continued for the next several years until 2010 with some differences between existing and new stores, but with the cap remaining at 30 percent for all stores with a gross profit more than $800,000. There also was either a small franchise fee of $10,000 for stores with a gross profit under $200,000 that was entirely waived in the 2010 version of the store agreement. But who would want a store with a gross profit of less than $200,000? Only a single person living very frugally and with no kids or wife to hound him for money.

Welcome to the 2012 agreement. Throw out all prior formulas—the good and the bad. How is the franchise fee now computed? Here it is verbatim from the Franchise Disclosure Document:

“We will determine the franchise fee for each store depending on a number of factors, including, but not limited to, historical sales at the location, age of the location, the number of stores available for franchise in the area, and many other factors. The amount of the franchise fee for each store may vary significantly by location. We will provide you with a complete list of all stores available for franchise in the area in which you are looking, and the amount of the franchise fee for a particular store in which you are interested. We will update the list at the beginning of each month with the then-current franchise fee for each store available for franchise.

“If you are buying a current 7-Eleven franchisee’s interest in a franchise (a ‘goodwill store’), you may have to pay ‘goodwill’ to the selling franchisee in addition to the franchise fee. You will negotiate the ‘goodwill’ payment directly with the selling franchisee without our involvement.”

There is no longer any predictability, nor do we know exactly how the franchise fee will be computed (note the phrase “and many other factors”), who will determine the fee and, most importantly, will the resulting fee be reasonable so that a prospective purchaser for your store will pay it in addition to a decent goodwill payment, or will you pay that fee for a multiple.

Wait! You say you want more. Here is another option that SEI has to determine the franchise fee for a corporate store, new store or an acquisition store. The process is similar to the daytime game show “The Price is Right.” Here it is:

“If you are seeking to obtain a franchise for a store we: (a) are currently operating as an existing store; (b) are developing as a new store; or (c) are acquiring pursuant to an acquisition (all of which are a ‘corporate store’), we may elect to determine the franchise fee for such corporate store through an auction process in lieu of the franchise fee for the store as described above. The minimum bid for such corporate store would be the listed store franchise fee as described above, and certain interested candidates that we identify will have the opportunity to submit a sealed bid for the corporate store through a sealed bid process that we establish. We will notify all such interested candidates of the deadline for submitting the bids and how such bids must be submitted.”

It all comes down to SEI getting what the market will bear for its stores, and who can blame any business for maximizing profits? However, each time franchise fees increased, I have predicted that the company has finally overreached and no sane person will pay the franchise fees demanded. I was wrong before and I might be wrong again. We will have to wait and see what the new franchise fees will be compared to the last many years. I have never seen fees come down—they only travel north.

Don’t think this new method of determining franchise fees doesn’t affect you. Sooner or later, regardless of the version of the store agreement you signed, the issue of franchise fees will be involved in an important, if not critical, business decision you will make.

For instance, if your leasehold rights are lost, you will need to sign the new agreement that provides, among other things, for only a 10-year term with a renewal fee equal to 20 percent of the franchise fee that SEI states is applicable to your store at the time of renewal. Who knows what that number will be in the future?

You will also have to sign the new agreement when your store agreement expires, for many as soon as the year 2019. If you are thinking of franchising an additional store, a big part of your decision will be, “Is it worth it?” If you are looking to franchise a corporate store or a new store being built or acquired, you may have to compete with other prospects by bidding up the fee for a franchise store that may not have a past track record of sales to justify your bid. Those are just a few of the circumstances when high franchise fees will hit you hard in the pocket.

Of course, if you are trying to sell your store for its goodwill, a buyer will look at what he hopes will be the bottom line, but the higher the franchise fee the less a prospective purchaser will pay for goodwill. That is only common sense.

I hope I haven’t ruined your day or your retirement plans, which you hoped would be largely funded by a goodwill sale of your store(s).