Franchise fees and royalties: how to set them for your network

Turning an existing business into a franchise network requires a new financial balance: each franchised outlet must provide an income for its operator, while the franchisor must fund support and development. Simply copying other brands’ initial franchise fees and royalties is not enough. Each charge needs to be linked to tangible benefits or services, and you must check that both businesses can sustain the arrangement over time.

1. Separate set-up costs from ongoing support

The first step is to distinguish between the one-off work involved in bringing a franchisee on board and the support you will need to provide throughout the relationship. Start with your existing business, but factor in the additional work required to support independent business owners.

Initial activities may include:

• assessing the premises and adapting the design;
• providing initial training for the franchisee and their team;
• setting up management systems;
• providing hands-on support before and during opening.

Ongoing activities, meanwhile, include operational support, refresher training, regular visits, maintenance of shared systems and coordination of sales and marketing activities.

For each item, record the working hours, staff costs, travel expenses and external suppliers involved. Put a value on the founder’s time too: it may seem free today, but eventually that work will need to be handled by a properly resourced team or role.

The initial franchise fee is not simply reimbursement for these costs: it may also reflect the value of the business model and know-how transferred. However, understanding the cost of setting up a franchisee prevents you from charging an amount that fails even to cover the support you have promised. Likewise, royalties must fund ongoing services that you can actually deliver.

2. Check what a franchised outlet can afford

Before choosing a percentage, build a profit and loss forecast for an outlet run by a franchisee. Your own location’s results are a useful starting point, not a guarantee that its financial performance can be replicated.

Adjust for any particularly favourable circumstances: premises you own, unpaid work by family members, personal supplier discounts or customers whose loyalty is tied directly to the founder. Include realistic remuneration for the person running the outlet, alongside staffing, rent, utilities, insurance, maintenance and local marketing.

Then add all franchise-related costs, not just royalties: advertising contributions, compulsory software, minimum purchase commitments and other paid services. If the franchisor also earns revenue from supplying products, assess how purchase prices affect the franchisee’s margin.

Prepare conservative, base-case and optimistic scenarios, stating your assumptions clearly. Ask yourself:

• If sales fall below expectations, will there still be enough cash to meet current commitments?
• Does seasonality create months when a fixed fee becomes difficult to afford?
• How much capital is needed during the start-up period, before receipts stabilise?

Do not confuse profit with cash: stock, loan repayments and payment timings can absorb cash even when the profit and loss forecast looks positive.

3. Choose a simple, verifiable mechanism

A fixed royalty makes costs easier to forecast, but places a proportionately heavier burden on outlets with lower revenue. A percentage-based royalty moves in line with sales, but requires a clear calculation basis and reliable data. A hybrid model with a guaranteed minimum combines the two approaches without eliminating their risks.

Avoid formulas that are difficult to explain. If you choose a percentage of turnover, make clear how VAT, returns, discounts, gift vouchers, online sales and transactions through third-party platforms will be treated. Also define the reporting period, the records to be submitted and the verification procedures.

For the advertising contribution, specify which activities it funds and which remain the responsibility of each outlet. Clear, regular reporting helps maintain trust across the network, without blurring the distinction between this contribution and the fees charged for support.

Finally, model the franchisor’s finances assuming only a few openings and slow growth. If support for existing franchisees depends on fees collected from new joiners, the business model is fragile. Recurring income must be aligned with recurring commitments.

4. Translate the figures into precise contract terms

In Italy, franchising is governed by Law No. 129 of 6 May 2004. The agreement must be in writing to be legally valid and must expressly state, among other things, the level of investment and any initial franchise fees, how royalties are calculated and paid, and any minimum revenue the franchisee is required to achieve.

The law does not set standard fees: the sustainability of the amounts charged must be demonstrated through financial analysis, not assumed simply because they appear in the contract. For fixed-term agreements, the franchisor must guarantee a term long enough for the franchisee to recoup their investment, and in any event no shorter than three years, subject to early termination for breach of contract.

Have a lawyer check that the fees, services, payment deadlines, any adjustments and termination provisions are consistent with one another. With an accountant, review tax treatment, invoicing and the impact on cash flow. Scenarios presented to prospective franchisees must remain reasoned projections, not promises of returns.

In practice: before offering franchises, prepare two linked profit and loss forecasts, one for the franchisee and one for the franchisor. Only approve the initial fees and royalties once both businesses remain viable under a conservative scenario and every payment is governed by clear, understandable terms.