A friend of mine has been considering starting a franchise and asked me if buying a franchise means less worry about failing.

But as soon as I heard that question, one thought came to mind. Have you calculated the royalties?

When people start a franchise, the first thing they look at is the initial franchise fee. In the U.S., the average initial franchise fee is about $25,000, with the most common range being between $5,000 and $90,000 depending on the brand.

However, this franchise fee is a one-time payment. The real money that comes out of your account every month is the royalties.

According to the Federal Trade Commission (FTC) guidelines, franchise royalties are typically set between 4 to 12 percent of total sales. The term total sales is key here.

Royalties are calculated based on gross sales, not net profit. If you sold $50,000 in a month and the royalty rate is 6 percent, you must send $3,000 to the franchisor, even if you had a loss that month.

While the industry average falls within that 4 to 12 percent range, there are extreme cases where some brands charge as low as 1 percent or as high as 50 percent. The higher the brand recognition, the less room there is for negotiation.

Additionally, there are marketing fund contributions that are separate. Typically, an extra 1 to 4 percent of sales goes out, and depending on the industry, there can be overlaps where royalties of 7 to 10 percent coincide with marketing fees of 2 to 4 percent.

Moreover, many brands charge a technology fee ranging from $200 to $800 per store per month under the guise of a monthly system usage fee. While each fee may seem small, together they can take a significant chunk out of your monthly revenue.

For example, if your monthly sales are $50,000 and you spend $40,000 on labor, materials, and rent, you have $10,000 left. After paying the $3,000 royalty, your net profit drops to $7,000.

Many people sign contracts without considering these calculations, focusing only on the franchise fee and opening costs. Even if sales are good, royalties can thin out margins more than expected.

From the franchisor's perspective, the reason royalties are collected based on sales is that sales can be verified through the POS system, while net profit can vary greatly depending on how the franchisee accounts for expenses.

This means that regardless of whether franchise sales increase or decrease, the royalties going to the franchisor are consistently collected. It's hard to shake the feeling that the franchisee is the one bearing the risk when the business doesn't perform well.

We also need to touch on loans. Many franchise startups rely on SBA loans, and the default rate for franchise SBA loans is 16 percent. This means roughly one in six people has failed to repay their loans.

There are significant variations by industry. Retail franchise default rates are 16.5 percent, while healthcare franchises are around 5.1 percent, and lodging franchises are about 6.5 percent, which is relatively low. This indicates that the risk level can vary greatly even within the same franchise.

It's also important to check the closure rates. The median percentage of stores closing each year across franchise systems is 4.7 percent, and for 35 percent of all systems, this rate exceeds 7 percent.

So, not all franchises are safe. Closure rates and loan default rates vary widely by brand and industry.

So what should you do? Before signing a contract, request the FDD, or Franchise Disclosure Document, and start by looking at items 6 and 7.

Item 6 lists all regularly occurring costs like royalties and marketing fees, while item 7 shows the range of total initial investment. You need to plug these two into your projected sales to get a real picture.

Additionally, the contact information for existing franchisees is included in the FDD, so calling them to ask how much money is left after royalties is the most accurate way to find out.

If it were me, I would check the royalty rate and marketing contributions before looking at the franchise fee amount. The initial cost is a one-time payment, but royalties are ongoing until you close, so in the long run, they have a greater impact.