Franchising an Existing Business: A Guide to Royalties and Franchisor Support

When franchising an existing business, looking at competitors’ rates alone will not produce a sustainable royalty structure. You need an arrangement that allows the franchisor to maintain its promised support and helps franchisees understand the basis for their charges. This guide explains how to develop ongoing fees and franchisor support together, building a franchise community in which independent businesses work collaboratively.

1. Define the support you will provide before setting fees

Start by taking stock of the support you will provide after a franchisee joins, rather than comparing royalty rates. In existing company-owned outlets, owners and staff often perform tasks without consciously recognising them as support functions. Break these down into product development, marketing, supplier coordination, outlet visits, advice, system maintenance and other activities, then identify who handles each task and how much time it requires.

Your support schedule should include at least the following:

• Scope: What will you provide, and what will you exclude?
• Delivery method and frequency: How will you combine visits, online meetings, distribution of materials and other methods?
• Conditions of use: What is included in the standard fee, and when will additional charges apply?
• Support arrangements: Who is the point of contact, what are the service hours, and how will matters be handed over when the person responsible is unavailable?

For example, simply promising to ‘provide business guidance’ may create a gap between franchisees’ expectations and the franchisor’s intentions. Be specific about the activities involved: ‘Review monthly business figures and discuss improvements at a meeting.’ Guaranteeing sales growth is different from committing to support improvements.

Next, separate support costs into those incurred regardless of franchisee numbers and those that increase as more outlets join. If you cannot maintain support for existing franchisees without continually receiving new initial franchise fees, you need to review your ongoing fees or support arrangements.

2. Choose a royalty model that balances affordability and administration

The main models are a fixed fee, a percentage of sales and a fee based on gross profit. None is universally better than the others. Consider what drives increases in your support costs, how the burden on franchisees will vary and whether the figures can be calculated accurately.

A fixed fee makes invoices predictable, but places a greater relative burden on franchisees during periods of low sales. For the franchisor, revenue will not rise automatically even if busier outlets need more support.

A percentage-of-sales royalty varies with sales, but sales do not necessarily mean profit. If discounts or rising costs reduce a franchisee’s profit, the royalty may remain unchanged for the same level of sales.

A gross-profit-based royalty requires clear rules on purchase costs, wastage, stock discrepancies and similar items. Do not rely on agreement over the term ‘gross profit’ alone. Set out the calculation in the contract and explain any differences from the accounting figure.

If you use a percentage-based model with a minimum payment, or a similar arrangement, model the charges not only for a typical month but also for the opening period, quiet periods and temporary closures. Check that the terms do more than simply stabilise the franchisor’s income, and assess whether franchisees can reasonably sustain the payments.

3. Clarify the calculation base and the boundary between included services and extra charges

Fee disputes often arise less from the rate itself than from ambiguity over what it applies to and what it includes. For a percentage-of-sales royalty, decide how to treat Japanese consumption tax, returns, discounts, loyalty points, gift vouchers and delivery charges. For orders placed online and fulfilled by an outlet, you also need rules on which outlet is credited with the sale.

For example, an outlet using a third-party delivery service will receive less than the customer’s order total once commission has been deducted. State clearly in the contract which amount forms the royalty base, and ensure that the sales management system can reproduce the same calculation. Establish an adjustment method for returns processed in the following month as well.

Organise charges other than royalties by their purpose:

• Initial franchise fee: Specify what the fee pays for, such as rights granted and pre-opening support provided at the start of the agreement.
• Training fees: Distinguish between the standard number of participants, additional training places, and responsibility for travel and accommodation costs.
• Advertising contributions: Define the advertising activities covered, how spending will be reported and how unspent funds will be treated.
• System fees: Identify mandatory and optional functions, and specify which upgrade or renewal costs are covered.

If you hold a security deposit, distinguish it from payment for services and define which liabilities it may be applied against and the conditions for its return. If the purchase price of products specified by the franchisor includes income for the franchisor, make this identifiable as a cost separate from royalties. Franchisees need a complete picture of what they will pay, not just a fee schedule.

4. Reflect Japanese legal requirements in the agreement

Japan has no single comprehensive law governing all franchises. That does not mean there are no specific legal requirements: general laws, including the Civil Code, apply to franchise agreements, and transactions between franchisors and franchisees are also subject to the Antimonopoly Act.

The Japan Fair Trade Commission’s guidelines on franchise systems under the Antimonopoly Act address trading issues on the basis that franchisees are legally independent businesses. These guidelines are not legislation themselves; they explain the approach to applying the Act. Where a franchisor holds a superior bargaining position, conduct such as unilaterally imposing substantially disadvantageous burdens may constitute an abuse of that position. Including a provision in the contract does not make every fee change permissible.

Franchisors operating a ‘specified chain business’ under the Small and Medium-sized Retail Business Promotion Act must, under Article 11, provide a written document containing prescribed information and explain it before an agreement is signed. Whether a business falls within this category is not determined simply by calling it a retail or food-service business. It depends on criteria such as ongoing product supply or arrangements for supply, management guidance, use of branding and the collection of payments when franchisees join. Obtain specialist advice on whether the requirements apply, including the fee information that must be disclosed.

The agreement should specify the calculation formula, reporting deadlines, invoice dates, payment dates and procedures for correcting calculation errors. For changes to royalty rates, define the grounds for change, consultation process, notice period and effective date, and obtain legal advice on how these provisions interact with existing agreements. If you verify franchisee sales, clearly define the scope and method of checks, taking care to avoid unrestricted demands for documents.

5. Test invoicing and support reporting before recruiting franchisees

Once you have a proposed fee structure, use actual transaction records from company-owned outlets to produce sample invoices as though those outlets were franchisees. Test returns, discounts, closures and additional training as well as ordinary sales. The key check is whether accounting staff and outlet staff can independently calculate the same amount from the same records.

At the same time, create records of the support delivered. Log visit dates, matters raised, advice given and points to follow up, then check whether the promised support is being provided. For funds earmarked for a particular purpose, such as advertising contributions, a system for reporting activities and expenditure helps align expectations with franchisees.

Establish a single point of contact for fee enquiries and a procedure for reviewing disputed invoices. If recruitment staff independently promise discounts or free support, the contractual terms and actual charges may diverge. Record who approved any exception, how long it applies and what fees will apply afterwards.

Practical takeaway: Before recruiting franchisees, prepare three documents: a support schedule, a fee and calculation schedule, and a sample invoice. A franchise community built on trust starts with both parties being able to explain the value provided and the amount paid.