Franchise royalties: how to set them before expanding

Setting royalties is not simply a matter of choosing a percentage similar to that charged by other brands. To turn an existing business into a franchise, you need to establish a fee structure that is sustainable for the franchisor, affordable for the franchisee’s operation and easy to verify. In the franchise sector, this clarity helps build trust from the very first negotiation.

1. Define what the royalties cover

Before discussing amounts, describe what the recurring charge pays for: the use of the brand and business system, the franchisor’s ongoing services, or a combination of these. This definition should reflect the model actually being offered, rather than a list of benefits that do not yet exist.

Distinguish royalties from other charges. The initial franchise fee serves a different purpose from recurring fees; advertising contributions, software licences and additional services must also be identified where they are mandatory. Grouping everything under a single label makes it harder for prospective franchisees to assess the financial implications.

Prepare an internal reference sheet with four fields:

• Purpose: which rights and services the charge covers.
• Recipient: which company receives the payment.
• Frequency: when the amount is calculated and when payment is due.
• Scope: what is included and what may incur a separate charge.

This sheet will guide financial modelling and the drafting of documents. It does not replace legal and accounting review.

2. Choose a verifiable basis for calculation

There are several ways to structure royalty payments. The key is to understand how each would work in the business you intend to franchise.

Percentage of turnover: this tracks sales volumes but requires a precise definition of the revenue included. Clarify how cancellations, returns, discounts, instalment sales and sales through platforms are treated. Leave no doubt about whether taxes and commissions are included in or excluded from the calculation base.

Fixed recurring fee: this makes the charge more predictable, but represents a proportionately greater burden when an outlet’s sales are lower. Also define how the fee will be adjusted, how often and when adjustments take effect.

Combined model: this may combine a percentage with a minimum fee. In that case, explain whether the minimum replaces the percentage-based amount when that amount is lower, or whether an additional charge applies. Ambiguous wording can significantly change how the cost is understood.

The chosen approach should allow both franchisor and franchisee to reproduce the calculation and reach the same result. If it regularly requires interpretation, the rule needs simplifying.

3. Test the impact on both sides of the relationship

Use actual data from the existing business to model the proposed charge. Include royalties in the outlet’s profit and loss statement alongside the franchisee’s other anticipated expenses, even if the company-owned operation does not currently make this payment.

Test lower, expected and higher sales scenarios, as well as the outlet’s initial trading period. Look at both operating profit and cash flow: a charge that an established operation can afford may put pressure on a newly opened outlet.

From the franchisor’s perspective, compare projected recurring income with the obligations it will take on. Consider the work involved in ongoing support and the capacity to provide it, without relying on rapid expansion to make the figures add up.

If the model only works with optimistic sales forecasts or promised services that exceed the budget, revise it before offering the franchise. Low royalties do not automatically make a franchise attractive; high royalties do not demonstrate quality either. The test is whether the fees, the support delivered and the financial viability are consistent with one another.

4. Align the charges with Brazil’s Franchise Law

In Brazil, Law No. 13,966/2019 governs business franchising and repealed Law No. 8,955/1994. Article 2 requires the franchise disclosure document, known locally as the Circular de Oferta de Franquia (COF), to provide clear information about recurring fees and other amounts payable to the franchisor or third parties it designates, detailing the calculation bases and what the payments cover or their purpose.

Simply stating “monthly royalties” or quoting a percentage is therefore not enough to explain the obligation. The COF and the agreement must be consistent on the formula, payment deadlines, adjustments and applicable conditions.

In a standard private franchise offering, the COF must be provided at least ten days before the agreement or preliminary agreement is signed, or before any fee is paid to the franchisor or to a person or company connected with it. Do not collect payments early to secure commercial terms.

5. Prepare the calculation process

Before signing the first agreement, produce a trial statement using data from the existing operation. Show the calculation base, any adjustments, the formula applied and the amount due.

Define which records substantiate sales, who checks discrepancies and how any corrections will appear in the next charge. Also document any special introductory terms, with a clear duration and criteria.

Practical takeaway: only finalise your royalty structure once you can explain what it covers, demonstrate its viability and reproduce the calculation without ambiguity. Then check that the same rules are reflected in the COF, the agreement and your financial procedures.