Franchising: how to check royalty calculations

A seemingly modest royalty can become a significant expense if it is applied to a calculation base that is too broad or poorly defined. Before joining a franchise network, simply comparing the percentages quoted in sales presentations is not enough: you need to establish which transactions generate fees for the franchisor, when those fees accrue and how they can be checked. The aim is to turn a contractual clause into a verifiable cost before you sign.

1. Start with the formula in the contract

In Italy, franchising is governed by Law No. 129 of 6 May 2004. Article 3 requires the contract, which must be in writing to be valid, to expressly state how royalties are calculated and paid. The law defines royalties as a percentage of turnover or a fixed fee, which may also be paid in periodic instalments.

The legislation does not set a standard rate: you need to assess whether the proposal is financially viable based on the terms actually agreed. A sales description such as ‘royalties on turnover’ is no substitute for a sufficiently precise contractual formula.

First, identify the proposed model:

• Fixed fee: how much is payable for each period, and when payments begin.
• Percentage: which rate applies, and to what amount.
• Combined formula: whether the fixed fee and percentage are added together, or one is offset against the other.
• Tiers: which thresholds change the rate, and whether the new rate applies only to the amount above the threshold or to the full amount.

If adjustments are предусмотрed, ask which benchmark determines them, how often they occur and when they take effect. Do not assume an initial royalty-free period is guaranteed if it appears only in the brand’s presentation.

2. Define what is included in the calculation base

The most sensitive step is understanding what words such as ‘sales’, ‘receipts’ or ‘turnover’ mean in the contract. These terms should not automatically be treated as interchangeable.

Ask for a definition that clarifies at least the following:

• VAT: is the reference amount inclusive or exclusive of tax?
• Discounts: is the calculation based on the list price or the price actually charged to the customer?
• Returns and refunds: do they reduce the calculation base and, if so, in which period?
• Unpaid sales: do they still generate royalties?
• Gift vouchers and advance payments: are they counted when payment is received or when the goods or services are supplied?
• Orders through platforms: is the calculation based on the amount paid by the customer or the amount remaining after commission?

For purchases made on the network’s website and collected in-store, also check who is credited with the sale and whether any payment to the franchisee forms part of the calculation base. The aim is not to debate the sales strategy, but to avoid paying royalties on transactions you had not included in your financial projections.

There is no single contractual answer that can be assumed to apply across all networks. Definitions must reflect how the business actually operates and be consistent with its accounting records. Ask your accountant to check this alignment.

3. Check deadlines, statements and adjustments

The same royalty can affect cash flow differently depending on when it must be paid. If the fee accrues on invoiced sales but the customer pays later, the franchisee may have to fund the payment in advance.

Map out the full cycle: who prepares the royalty statement, when it is sent, when the invoice is issued and when payment is due. Check whether advance payments are required and how any balancing payment or credit is calculated.

Also ask what procedure applies to errors. A return recorded after the month-end close, for example, should be dealt with clearly in subsequent calculations. The contract should make it possible to identify the supporting documents required, the deadlines for raising disputes and the process for any adjustments.

If the franchisor can check the underlying data, examine the scope of those checks and any costs that may be charged to you. The calculation must be reproducible: using the same transactions and rules, the franchisee and franchisor should arrive at the same result.

4. Test the mechanism before accepting it

Ask the franchisor for a completed sample royalty statement and work through it with your adviser. You do not need an optimistic sales forecast: you need to test the formula in practical situations.

Prepare three scenarios: a normal trading period, one with extensive promotions, and one with returns or delayed customer payments. For each, calculate the royalty due, the payment date and the amount left after costs directly linked to sales. Keep other fees separate so that you do not confuse the royalty with the total cost of the franchise arrangement.

If different interpretations emerge, ask for the contractual wording to be clarified before signing. The duty to act loyally, fairly and in good faith during negotiations under Article 6 of Law No. 129/2004 makes a transparent discussion of the financial terms particularly important.

In practice: do not agree to a percentage alone. Agree to a written formula, a payment schedule and a checked example: these are the tools that will help you understand how much you will actually pay.