Franchise royalties: what to check before you buy

A seemingly low royalty rate can put more pressure on cash flow than a higher one. It all depends on the calculation basis, minimum charges and payment timing. Before taking on any commitments, prospective franchisees need to turn the commercial offer into figures they can verify.

1. Identify exactly what you are paying for

Royalties are recurring payments under a franchise arrangement. They may cover the use of the brand, the operating system or services provided by the franchisor. They are not automatically interchangeable with the initial franchise fee, advertising contributions or payments for tools: each charge should be identified separately.

In Brazil, Law No. 13,966/2019, which repealed Law No. 8,955/1994, governs business franchising. Article 2 requires the franchise disclosure document, known locally as the Circular de Oferta de Franquia (COF), to clearly state recurring fees and other amounts payable to the franchisor or designated third parties, detailing how they are calculated and what they cover.

The law requires transparency but does not set a single royalty rate. So do not accept ‘standard across the network’ as sufficient justification for a charge.

Ask for a breakdown showing:

• The name of each recurring charge and who receives it.
• The fixed amount, percentage or formula that applies.
• The calculation basis and frequency.
• When charging begins and when payment is due.
• Any minimum charges, adjustments and circumstances in which the charge may change.

If the offer advertises ‘no royalties’, check whether the franchisor receives payment in another direct or indirect form, such as amounts built into the price of products supplied. The absence of a royalty charge does not mean there are no ongoing costs.

2. Examine the calculation basis before comparing percentages

The key question is not just ‘what percentage?’ but ‘a percentage of what?’ The contract should make clear which amounts are included in the calculation, without relying on later verbal explanations.

If the charge is based on turnover, check how that term is defined. Look at how discounts, cancellations, returns, taxes, instalment sales and sales through platforms are treated. Do not assume that card processing fees or app commissions will be deducted from the calculation basis.

Consider this purely illustrative example: an outlet makes R$100,000 in sales during the month and pays royalties of 5% on that turnover. The charge will be R$5,000. If some of those sales have not yet been paid for, the amount due may remain the same, depending on the contract. Making a sale and receiving payment do not necessarily happen at the same time.

Also ask how subsequent adjustments work. Does a sale cancelled after the calculation period has closed generate a credit the following month? Who provides the supporting evidence? Is there a deadline for disputing the calculation?

Ask for a complete worked calculation, using hypothetical figures and including an instalment sale, a discount and a return. This exercise can help identify ambiguities before they become financial disputes.

3. Test the cash-flow impact of minimum charges, grace periods and adjustments

Royalty arrangements can take different contractual forms: a fixed amount, a percentage or a combination of rules. If there is a minimum charge, check whether it replaces the percentage-based amount when that amount is lower, or is added to it. The difference has a substantial effect on the cost.

Build a monthly spreadsheet for three scenarios: sales below expectations, sales in line with your plan and higher sales. In each case, record turnover, cash received, royalties and the cash remaining after other expenses.

Pay particular attention to:

• Monthly minimum: what proportion of sales does it represent in a weak month?
• Grace period: are charges waived entirely for that period, or merely deferred and collected later as an accumulated amount?
• Start of the obligation: does it begin when you sign, when the outlet opens or on another specified date?
• Adjustments: what index, frequency and rules apply to changes in fixed amounts?
• Charging bands: does a change in the percentage apply to all turnover or only to the amount above the threshold?

Do not compare brands on the royalty rate alone. Compare the actual cost under the same sales and payment-receipt conditions. A rule that is manageable in strong months may put cash flow under strain during the outlet’s early stages.

4. Check calculation, billing and dispute procedures

Before signing, compare the rules set out in the COF with the contract and its annexes. Any discrepancies concerning the calculation basis, payment deadline or minimum charge need clarification in writing, not just a message saying that ‘it works differently in practice’.

Check who calculates the amounts, which reports support the charges and how the franchisee can verify the data. Identify the procedure for disputing errors, correcting payments and dealing with late payments. A review by an accountant and a lawyer can help distinguish the financial impact from the legal obligations.

The COF must be provided at least ten days before the contract or preliminary agreement is signed, or before any fees are paid to the franchisor or a person or company connected to it, subject to the statutory exception for public selection procedures.

Practical conclusion: only proceed once you can reproduce the royalty calculation yourself, test its impact in weak months and find every applicable rule in writing.