What’s the difference between a deposit and an initial fee?

Investing in a new franchise opportunity can be exciting, but it also involves careful financial planning. One area that often causes confusion for prospective franchisees is how deposits and initial fees work. Here we break down key considerations, with insights from legal experts in the franchising sector…

Do I have to pay a deposit or franchise fee when investing in a franchise?

Not all franchisors require a deposit upfront, but most expect an initial fee. Vicky Wilkes, head of legal at Aston Villa Football Club, explains, “The franchisor may ask you to pay a deposit at the point you decide to go ahead with a franchise, but before you sign the franchise agreement, often to secure a particular territory.”

Deposit vs initial fee

It’s important to understand the difference between a deposit and the initial fee. A deposit is usually smaller. The franchisor may use it to research a territory or help find a suitable property.

Meanwhile, the initial fee covers the cost of joining the franchise system. Wilkes advises that you should always ask what you will receive in return for a deposit before paying it.

Are deposits refundable if I change my mind?

Deposit refundability depends entirely on the agreement you make with the franchisor. Wilkes explains, “There is no rule as to whether a deposit should be refundable and the answer will ultimately be down to the bargaining position of the parties.”

Often, deposits will be refundable if you do not sign the franchise agreement. However, the franchisor may deduct “the reasonable costs involved in carrying out negotiations with the prospective franchisee.” Any refund terms should be clearly documented in writing.

When and how should I pay the initial franchise fee?

The timing of the initial fee varies depending on the franchisor and the franchise concept. Wilkes explains, “It is fairly common that the franchisor will expect you to pay a franchise fee as a show of commitment at the point you sign the franchise agreement, but not before.”

This fee covers the initial range of services provided by the franchisor and the charge for entry into the system. In some cases, it may also include equipment, products or the cost of a turnkey fitting out of premises.

Can I pay the initial fee in instalments?

Shelley Nadler, legal director at Bird & Bird notes that this is sometimes possible. “It might be that you pay a proportion on entering into the franchise agreement. If you then have to find premises in which to trade, the remainder of the fee is payable when you acquire the premises.”

John Pratt, senior partner at Hamilton Pratt, explains that instalment payments are rarer for several reasons. He says, “A franchisor might be ‘nervous’ if a franchisee cannot afford to pay the initial fee, because this might demonstrate that you are insufficiently funded.”

Additionally, once a franchisee has the franchisor’s knowledge and materials, it may be difficult to collect payment later.

However, some franchisors support franchisees who show potential. Pratt adds, “Some franchises do allow franchisees to pay in instalments with a view to the first three months trading being profitable. This means franchisees are then able to generate sufficient turnover and profit to fund subsequent payments.”

What should I do before paying any deposit or fee?

Clarity and documentation are crucial. Before paying anything, ensure you have a written record from the franchisor confirming the amount, purpose of the payment and conditions for any refund.

By understanding the difference between deposits and initial fees, knowing when payments are due, and confirming refund terms in writing, you can make informed decisions and avoid unexpected financial pitfalls.