Franchising an Existing Business: Structuring Franchise Fees, Security Deposits and Pre-opening Costs

When turning an existing business into a franchise, setting initial charges solely by reference to competitors’ price lists is risky. You also need to decide what the franchisor will provide, when costs will arise and what will be refunded if the outlet cannot open. Separating franchise fees, security deposits and pre-opening charges helps franchisees plan their finances and provides a foundation for trust across the franchise network.

1. Separate payments by purpose before setting amounts

Start by listing all the payments you expect to receive from prospective franchisees. Rather than grouping them together as an ‘initial costs package’, set out what each payment covers, who receives it, when it is due and whether it is refundable. The categories below are examples for planning purposes, not standard statutory classifications.

Cost category	What to clarify	Points requiring particular care
Franchise fee	Payment for the rights granted on joining and initial support	Avoid overlap with separate charges for trade mark use, training or other services
Pre-opening charges	Payment for specific services, such as on-site support and preparatory work	Define the scope, deliverables and additional charges
Security deposit	The obligations secured by the money held	Specify what it may be applied against and the conditions for its return
Payments to third parties	Fit-out, equipment, lease-related costs and similar expenses	Show these separately from payments to the franchisor

For example, if the franchise fee includes opening support but you also charge a separate preparation fee for the same work, your charges will conflict with your explanation. Conversely, if the scope of the franchise fee is vague, you may face unlimited requests for unplanned on-site support.

Calling a payment a security deposit does not, by itself, distinguish it from a franchise fee. Establish whether it is money held with an expectation of repayment or, in substance, a non-refundable payment, and ensure that the contract and the way you manage the funds are consistent.

2. Use company-owned outlet opening records to establish a basis for charges

An existing business will have accumulated experience in tasks such as assessing premises, preparing for recruitment, setting up equipment and providing support on opening day. However, unpaid time contributed by the founder or help from staff at other outlets may not have been recorded as opening costs.

Begin by reviewing recent openings or trial operations, recording who carried out each task, the time involved, travel expenses and outsourced costs. Then distinguish between work that franchise outlets will also need and work required only because the outlet was company-owned. The aim is not to set the franchise fee solely on a cost basis, but to check whether you can consistently deliver the support you promise.

Define what the standard fee covers alongside the circumstances requiring an additional quotation. For travel to distant locations, schedule changes requested by the prospective franchisee or extra on-site support, specify who must approve the work and when the price will be confirmed.

The financial plan presented to prospective franchisees should show not only payments to the franchisor, but also separate allowances for securing premises, equipment, stock and working capital after opening. Clearly label unconfirmed costs as estimates and state the assumptions behind them. It is important not to confuse ‘the costs of joining the franchise’ with ‘the total funding needed to start trading’.

3. Plan payment timing and settlement if the outlet cannot open

Collecting the full amount when the contract is signed will not suit every business. Requiring a large payment before there is a clear prospect of securing premises or obtaining the necessary licences and approvals increases both the burden on the prospective franchisee and the risk of disputes.

Consider linking payments to milestones such as contract signing, confirmation of premises, the start of preparatory work and opening. This does not mean that instalments are always legally required; it is a way of aligning payments with the franchisor’s progress in meeting its obligations.

Before recruiting franchisees, check how you would settle payments in at least the following situations:

• The prospective franchisee withdraws before preparatory work begins.
• The agreement for the premises falls through, halting the opening plan.
• The necessary licences or approvals cannot be obtained, so trading never begins.
• The franchisor’s support arrangements are not ready, preventing the outlet from opening on the planned date.
• Some support has been completed, but the remaining work is not carried out.

For each scenario, distinguish between work not performed, completed services, non-cancellable outsourced costs and money held on deposit. Retain evidence, such as work records and invoices, for any deductions, and decide who will prepare the settlement statement.

Do not assume that a single clause stating ‘no refunds under any circumstances’ will cover every situation. Ask a lawyer to review the refund conditions and the enforceability of the clauses, taking account of circumstances on the franchisor’s side and any unfulfilled obligations.

4. Check Japanese disclosure requirements and the Antimonopoly Act

Japan has no single law comprehensively governing all franchises. However, disclosure duties apply where specified conditions are met, and general laws also govern transactions between franchisors and franchisees.

Article 11 of the Act on the Promotion of Small and Medium-sized Retail Business requires franchisors operating a ‘specified chain business’ under the Act to provide prospective franchisees with a document setting out prescribed information, and to explain it, before the contract is signed. Payments collected on joining are among the matters that must be disclosed.

Whether a business falls within this category does not depend simply on whether it calls itself a franchise. The assessment considers requirements such as having mainly small and medium-sized retailers as members; ongoing sales of goods, or arrangements for their sale, together with management guidance under standard-form contracts; use of trade marks or similar identifiers; and collection of payments on joining. Even a restaurant business may fall outside the category, for example if the supply of goods is not a contractual condition.

The Japan Fair Trade Commission’s Guidelines Concerning the Franchise System under the Antimonopoly Act also identify conduct that may raise concerns under the Act, including the information provided during recruitment and transactions after joining. The nature of initial payments and the conditions for their return are important to a prospective franchisee’s decision. Recruitment practices that create a misleading impression of terms being substantially more favourable than they actually are, or the use of a superior bargaining position to impose unfair burdens, may be problematic.

Falling outside the definition of a specified chain business does not mean that explanations can be omitted. The Civil Code is also relevant to contract formation, performance and repayment disputes. Check that your fee schedule, recruitment materials and contract are consistent, including with the way payments are actually collected.

5. Test the arrangements with a fee ledger before recruitment begins

Fee planning does not end when the contract is finalised. Create a fee ledger for each prospective franchisee to track amounts invoiced, payment dates, support delivered, deposit balances and approvals for additional charges. Ensure that accounting and opening-support staff can see what the sales team has promised.

For security deposits, you need to be able to track each franchisee’s balance, the obligations against which the deposit will be applied, notice before any deduction and the timing of repayment of the remainder. Do not determine the accounting or tax treatment by the payment’s name alone; ask a tax adviser to confirm the treatment based on its substance.

Finally, use a fictional prospective franchisee to run through the entire process, from application to a delayed opening and final settlement. Before recruitment begins, correct any points where different staff members calculate different refunds or cannot explain the basis for an additional charge.

The practical test is whether you can explain, for every initial payment, ‘what it is for, when it is collected and under what conditions it will be returned’. Start with a one-page schedule of charges, then align both the contract and day-to-day operations with it.