Franchising in Canada: Setting Your Royalty Fees

Turning an existing business into a franchise means deciding how the franchisor will earn revenue over time. Poorly judged royalty fees can undermine franchised outlets or leave too few resources to support them. In the Canadian franchise market, the aim is to develop a formula that is understandable, verifiable and sustainable for both parties, rather than simply copying another brand’s rate.

1. Start with actual costs, not a competitor’s rate

Begin by distinguishing between the initial franchise fee, ongoing royalties and other mandatory charges. The first covers initial entry into the network; the second provides recurring revenue for the franchisor. Technology fees and advertising contributions should remain separately identifiable, even when collected together.

Next, prepare an annual budget for the franchisor’s ongoing activities: operational support, continuing training, network coordination, shared tools and administration. Separate costs that increase with each outlet from those that remain relatively fixed. Avoid counting any expense twice if it is already funded through a separate contribution.

Compare this budget with expected revenue at different network sizes. A formula that works with many outlets may leave a substantial shortfall in the early stages. Conversely, making the first franchisees bear all the launch costs could make their businesses unattractive to operate.

A useful deliverable: a summary explaining the economic rationale for each charge, who receives it and which expenses it covers. This will provide a basis for discussions with your accountant and lawyer, without turning every internal expense into a contractual commitment.

2. Define the basis of calculation precisely

A royalty based on turnover rises and falls with sales, but not necessarily with profit. A fixed fee makes forecasting easier for the franchisor, while placing a heavier burden on an outlet when business slows. A hybrid formula or one with a minimum payment therefore requires particularly careful modelling.

The agreement should allow the calculation to be reproduced without ad hoc interpretation. Specify, in particular:

• which sales are included, both in-store and through digital channels;
• how sales taxes, refunds, discounts and cancellations are treated;
• when gift cards enter the calculation, to avoid double counting;
• how platform commissions and delivery charges are treated;
• the reporting period, reporting deadline and payment due date.

For example, a sale made through a platform may result in a bank payment lower than the amount paid by the customer. Calculating the royalty on that net payment or on the sale before commission produces different results. The choice must be explicit and applied consistently in accordance with the agreement.

Also establish a procedure for correcting an inaccurate return, including supporting documents, accounting reconciliation and any resulting adjustment. Automated collection is no substitute for a clear basis of calculation.

3. Test the formula on your pilot outlet

Before offering the franchise, apply the proposed charges to your pilot outlet’s accounts as though it were run by an independent franchisee. Include realistic remuneration for local management and the costs that the operator would actually bear.

Do not rely solely on an annual average. Examine quieter months, changes in margins and the time it takes to receive payments. Include all mandatory charges to measure their combined effect on cash flow.

Build several scenarios: performance in line with expectations, lower sales and increases in major costs. These exercises test the resilience of the model; they are not promises of results to present to prospective franchisees.

Check both sides of the equation. Does the outlet retain sufficient financial headroom after fees? Can the franchisor fund its ongoing operations from royalties without continually relying on new franchise sales? If not, revise the formula or the costs before recruiting franchisees.

4. Align the agreement, pre-contract disclosure and invoicing

In Canada, franchise-specific obligations are governed at provincial level. In Ontario, the Arthur Wishart Act (Franchise Disclosure), 2000 requires, among other things, a disclosure document containing material facts and the relevant agreements. Subject to statutory exceptions, it must be provided at least 14 days before a franchise-related agreement is signed or any payment is made.

Royalties and other mandatory charges must be described in accordance with the applicable requirements. Their presentation in the disclosure document, agreement and invoicing systems must be consistent. Have the rules checked for each province in which you grant a franchise, rather than assuming that one document will work everywhere.

Quebec has no franchise-specific legislation; the Civil Code of Québec governs matters including contractual obligations and good faith. The absence of a specific disclosure regime does not remove the need to explain financial commitments clearly.

Finally, any provision for increases must have clearly defined parameters: the mechanism, timing, notice period and any limits. Do not assume that changing the operations manual allows you to alter contractual fees freely.

Key takeaway: before making any offer, have a complete fee formula reviewed and validated, tested on the pilot outlet and designed so that calculations can be checked using ordinary accounting records.