Hong Kong Franchise Royalties: Clarify Turnover Definitions and Minimum Charges Before Signing

When comparing franchise brands in Hong Kong, prospective franchisees often ask only about the royalty rate, overlooking the amount to which it applies. The same rate can produce different costs depending on whether it is applied to customer payments, transaction values before platform deductions or the money actually received by the outlet. A lasting franchise relationship starts with clear written terms on the calculation basis, reconciliation procedures and authority to change charges—not arguments after the business opens.

1. Check what royalties cover and when they start

Royalties are generally fees paid by franchisees for the ongoing use of a brand, its operating system and related support. Exactly what they cover, however, depends on the contract. They do not necessarily include software, training, marketing or outlet visits, nor do they mean that the franchisor guarantees profitability.

Ask the franchisor for a complete fee schedule, listing the company receiving each payment, the payment currency, billing cycle and start date. In particular, confirm whether charges begin immediately after signing or only when trading starts. How are soft openings, temporary closures and fit-out periods treated? If a separate system fee is charged for the same service, ask how it differs from the royalty rather than comparing a single percentage in isolation.

Also check which takes precedence: the contract, the fee schedule or the operations manual. If the contract allows the franchisor to change fees by updating the manual, seek to make the royalty calculation method a core term that cannot be changed unilaterally.

2. Define ‘turnover’ transaction by transaction

‘Gross turnover’ may sound clear, but it can include amounts not yet received, sums already refunded or even money that is not the outlet’s income. Before signing, prepare a transaction checklist and ask the franchisor to confirm each item:

• Delivery platform orders: Are royalties calculated on the selling price before platform commission or on the amount remaining after commission? Who receives delivery charges and platform service fees, and are these included?
• Discounts and vouchers: Does the calculation use the original or discounted price? When are subsidies from the franchisor or platform recognised as revenue?
• Refunds and cancellations: Can royalties already paid be credited against the next billing period? What evidence is required for refunds made in a later month?
• Gift vouchers, prepaid packages and deposits: Are royalties charged when payment is received, when a voucher is redeemed or when the service is completed? How is double charging at both sale and redemption avoided?
• Money collected on behalf of others and tips: Can sums genuinely collected for third parties, and tips passed on to staff, be excluded?

For example, after a customer pays for a delivery order, the platform deducts its commission before settling with the outlet. If the contract uses the pre-commission amount, the franchisee must bear both the platform commission and royalties calculated on that higher base. This is not necessarily unreasonable, but it must be factored into costs from the outset. The amount credited to the bank account cannot simply be assumed to be the royalty calculation basis.

Include agreed transaction examples in a schedule to the contract, and specify what happens if an example conflicts with the main wording. A verbal assurance that something ‘would not normally be included’ offers little dependable protection.

3. Test minimum charges against low-season cash flow

Some arrangements use a fixed monthly fee, tiered rates or the higher of a turnover-based royalty and a minimum charge, rather than a straightforward percentage of turnover. A minimum charge means royalties may not fall in line with revenue.

Ask the franchisor for a formula you can check independently:

Royalty for the period = contractually defined turnover × applicable rate; if a minimum charge applies, compare the two using the agreed method.

For tiered rates, clarify whether a new rate applies only to turnover above the threshold or to all turnover for the period. Also confirm whether royalties for multiple outlets are calculated separately or on a combined basis.

When preparing cash-flow forecasts, test normal trading, the low season and a temporary closure separately, then add rent, wages, platform commissions and other fixed costs. The aim is not simply to rely again on a projected payback period, but to identify whether minimum royalties could create a funding shortfall in low-revenue months.

If payments involve a foreign currency, specify the exchange-rate source, conversion date and who bears bank charges. If the contract requires the franchisor to receive a specified net amount after taxes and charges, ask a Hong Kong tax adviser to assess whether this could increase the franchisee’s costs.

4. Make audit and fee-dispute procedures protect both parties

The franchisor may require access to the point-of-sale system, sales reports or accounting records to verify royalties. Franchisees should, in turn, seek a detailed calculation for each billing period so they can reconcile invoices against platform settlements, refunds and point-of-sale records.

The contract should specify reporting formats, submission deadlines, deadlines for challenging invoices and how discrepancies will be paid or credited. For disputed amounts, consider negotiating an arrangement under which the undisputed portion is paid first, while the disputed amount alone does not trigger suspension of franchise rights or default action during reconciliation. This protection must be negotiated; it is not an automatic right.

Audit clauses should also limit the scope of access, require reasonable notice, impose confidentiality obligations and clearly allocate audit costs. Avoid vague arrangements that make the franchisee liable for the full cost of an audit whenever even a minor discrepancy is found.

If point-of-sale data includes customer names, telephone numbers or membership records, it should not be handed over without restriction simply because the franchisor requests it. First establish whether transaction references and amounts are sufficient for the audit, and avoid transferring unnecessary personal data wherever possible.

5. Hong Kong has no franchise-specific disclosure regime, making written verification essential

Hong Kong currently has no franchise-specific legislation, nor a general requirement for mandatory pre-contract disclosure documents, a franchise registration system or a statutory cooling-off period for franchise arrangements. Do not assume that a franchisor must, by law, provide a standard fee disclosure document, or that you can cancel unconditionally after signing.

Royalty arrangements are governed primarily by common-law contract principles. Misrepresentations about fees before signing may engage the Misrepresentation Ordinance (Cap. 284) and related common-law principles, but whether damages or rescission are available depends on the facts. The collection, use and security of personal data must comply with the Personal Data (Privacy) Ordinance (Cap. 486). Hong Kong also has the Competition Ordinance (Cap. 619), so outdated claims that it has no competition law should not be relied upon.

Keep quotations, explanatory emails and calculation spreadsheets supplied by the franchisor. Then ask a Hong Kong solicitor to check whether they actually form part of the contract, paying particular attention to entire agreement clauses and unilateral amendment provisions.

Practical takeaway: Before signing, take one delivery order, one refund made in a later month and one gift voucher redemption, and ask the franchisor to calculate the royalty for each. If your answers differ, amend the contract before making payment.