Franchise royalties: how to check the true cost

A seemingly low royalty can become expensive if it applies to poorly defined revenue, comes with a compulsory minimum payment or is charged alongside other contributions. Before joining a franchise network, you need to understand not just how much the franchisor charges, but which amounts the charges apply to and under what rules. This will help you compare offers without mistaking an attractive percentage for a financially sustainable contract.

1. Start with the contractual definition of royalties

In Italy, franchising is governed by Law No. 129 of 6 May 2004. Article 1 defines royalties as a percentage charged by the franchisor to the franchisee based on turnover, or as a fixed amount, which may also be paid in regular fixed instalments.

Article 3 requires the contract to be in writing to be valid and to state expressly how royalties are calculated and paid, together with any minimum takings the franchisee must achieve. A minimum takings target and a minimum royalty payment are not the same thing: if both appear, they need to be examined separately.

Article 4 also requires a complete copy of the contract, with the prescribed attachments, to be supplied at least thirty days before signing. Use this period to have an accountant work through the financial arrangements and a lawyer review any unclear clauses.

Do not rely solely on the sales presentation. Ask for any clarification that could affect what you have to pay to be included in the contract or in an attachment expressly referred to in it.

2. Establish exactly what the percentage applies to

The word ‘turnover’ alone does not make a calculation transparent. You need to know which transactions are included in the calculation base and when they are counted. Ask for a definition that addresses at least the following points:

• VAT: are charges calculated on amounts excluding or including tax?
• Returns and cancellations: in which period are customer refunds deducted?
• Discounts and promotions: is the calculation based on the price actually paid or on another agreed value?
• Unpaid sales: does the royalty become payable when an invoice is issued or when payment is received?
• Gift vouchers and advance payments: is revenue counted when a voucher is issued, when it is redeemed, or under another rule?
• Third-party platforms: does the calculation base include commissions retained by intermediaries?

The aim is not to assume that one approach suits every business, but to avoid conflicting interpretations. For example, the revenue recognised for a sale through a platform may differ from the amount actually credited to your bank account.

Ask for a worked statement covering a month with ordinary sales, discounts and returns. For each item, it should show the starting amount, adjustments, the contractual royalty calculation base and the resulting royalty. If the statement does not match the wording of the contract, the ambiguity needs to be resolved before signing.

3. Separate minimum payments, advertising contributions and other fees

A reliable comparison distinguishes royalties from other recurring payments. These may include advertising contributions, fees for business management software, booking platforms or other compulsory tools. The label given to a charge does not change its effect on your profit and loss account.

Prepare a table with four columns: item, calculation base, payment deadline and scope for changes. For each payment, also check the applicable VAT treatment, taking care not to confuse the business cost with the total cash outlay shown on the invoice.

If there is a minimum royalty, clarify whether it replaces the percentage-based amount when that amount is lower, or whether it is an additional charge. These are very different arrangements. Also check what happens during months when the business is closed, during compulsory works or if the opening is delayed.

For the advertising contribution, ask which activities it funds, whether spending reports will be provided and whether further local advertising expenditure remains compulsory. Do not assume that a national contribution covers marketing for your outlet.

Finally, identify any provisions for changes, such as index-linked adjustments, scheduled increases or changes to services. Wording such as ‘current rates’ warrants clarification of the criteria, notice periods and limits governing any changes.

4. Test the calculation with three practical scenarios

Before accepting the offer, have the clauses applied to three situations: an ordinary month, a month with weak sales and a month with a high volume of returns. You do not need optimistic forecasts: you need to see how the contract works in practice.

For each situation, calculate royalties, contributions and compulsory fees separately. Then divide the total by the revenue used in that scenario to find the effective charge as a percentage of revenue. This is useful for comparing proposals with different fee structures. It is not the business’s profit margin, as other costs have yet to be included, but it makes the impact of fixed minimum payments visible.

Also check who prepares the statement, which data they use and how you can verify it. The contract should clarify deadlines, balancing adjustments, procedures for disputing charges and the consequences of errors. Ask how adjustments identified after the month-end are handled.

Practical tip: before signing, obtain a precise definition of the calculation base, a complete list of recurring payments and a numerical example consistent with the contract. In a franchise network, financial transparency starts with calculations that both parties can reproduce.