Setting Franchise Fees and Royalties When Moving into Franchising: Start with Support Costs

When expanding a successful outlet into a franchise, it is tempting to start by deciding how much to charge in franchise fees and royalties. But other questions come first: what support will the franchisor provide, how much will it cost, and can franchisees sustain their businesses after paying for it? A sound start for a franchise network requires a cost structure you can explain, rather than simply an attractive price for recruiting franchisees.

1. List the support you will provide before deciding what to charge

Before setting the franchise fee, list the franchisor’s responsibilities, from preparations for opening through to ongoing support. Do not overlook tasks currently handled by the business owner. Record the time spent on site assessments, initial training, on-site opening support, quality checks and responding to queries. For each task, also identify who is responsible and what they must deliver, so that the same support can be maintained when staff change.

Next, separate one-off support from recurring support. Work concentrated before opening, such as initial training, needs a different cost-recovery approach from activities required throughout the contract term, such as regular visits. If you charge separately for the right to use the brand and for training, explain clearly what each fee covers. Check that the same work has not been counted twice under different charges.

A practical support cost schedule should include:

• The name of each support activity, when it is provided and how many instances are included as standard
• The staff time required and the basis for calculating labour costs
• Direct expenditure, such as travel, training materials and external trainers’ fees
• How additional requests will be handled and who will pay for them
• Records that can verify whether the support was actually provided

Do not treat work currently performed unpaid by the owner as having no cost. Check whether the structure would remain viable if you hired staff or engaged external specialists to do it. Equally, do not justify a franchise fee by citing support you are not yet capable of providing.

2. Separate the roles of initial and recurring charges

Not all payments made when a franchisee opens an outlet serve the same purpose. Fees for joining the network, training fees, deposits subject to refund conditions and equipment purchase costs should be recorded separately. In your internal schedule, include not only the amount but also the recipient, payment timing, value added tax (VAT) treatment and refund conditions. Distinguish payments to the franchisor from those made directly to external suppliers.

In particular, do not treat deposits as income you can freely spend. Manage these funds with potential repayment obligations and settlement conditions in mind. If ongoing support is continually funded by initial joining fees, a slowdown in recruitment could undermine support for existing franchisees.

Royalties can be set as a fixed amount, linked to sales or based on a combination of the two. No single approach is always fairer. Fixed royalties make bills predictable, but can place a heavier burden on low-sales outlets. Sales-linked royalties vary with sales, but disputes can arise if the definition of sales or the method of verifying them is unclear.

If you choose sales-linked royalties, decide how VAT, refunds, discounts, delivery orders and gift voucher redemptions will be treated in the calculation. It also matters whether sales are counted when an order is placed or when payment is actually settled. The people responsible for contracts and accounts should be able to calculate the same bill from the same transactions.

3. Test the financial burden on both franchisees and the franchisor

Once you have a proposed fee structure, use actual data from company-owned outlets to calculate the burden on franchisees. Do not omit royalties simply because those outlets have not paid them to the franchisor. Include the proposed royalties and recurring charges, and assign a reasonable labour cost to the owner’s work, to produce a result closer to the realities of running a franchised outlet.

Do not look only at strong trading months: examine normal and weak periods separately. Check the impact of fixed royalties where costs such as rent and wages cannot easily be reduced. When sales rise, consider whether additional staffing and logistics costs will also increase. Do not present these calculations in recruitment materials as guaranteed earnings.

The franchisor needs the same scrutiny. Compare the support staffing, travel time and volume of enquiries required when the network is small with those needed as it grows. Not every activity increases in direct proportion to outlet numbers. Opening the first outlet in a new region, for example, may significantly change the cost of visits.

The key question is whether recurring income can fund the promised support without relying on new joining fees. If not, review the scope and delivery of support before immediately raising charges. You can distinguish between standard support and optional services, but avoid later turning support essential to normal operations into a paid extra.

4. Check the legal nature of each charge, not just its name

Franchising in South Korea is governed by specific legislation: the Fair Transactions in Franchise Business Act. Whether an arrangement qualifies as a franchise business is assessed by reference to factors including the use of business identifiers, consistent quality or operating methods, support and control, payment of franchise fees and an ongoing trading relationship. Simply calling the agreement a supply contract or consultancy agreement does not remove it from the Act’s scope.

Nor are franchise fees judged solely by their names. In addition to joining fees and royalties, certain amounts embedded in payments for supplied goods may qualify as franchise fees under the legislation. If you advertise ‘no royalties’ while generating franchisor income through supply prices, you therefore need to examine the substance of those supply arrangements and the associated disclosure obligations.

Article 6-2 of the Act provides the basis for registering franchise disclosure documents, registering amendments and notifying changes. When finalising your fee structure, check that the amounts and explanations in the disclosure document, franchise agreement and recruitment materials are consistent. You must also separately review whether initial payments are subject to escrow requirements and whether any exceptions apply. Do not start by assuming that every payment can be collected directly into the franchisor’s bank account.

It is also risky to assume that being a small business removes all legal obligations. The applicable scope, exceptions and payment collection arrangements must be checked against the transaction structure. Before you begin charging, it is prudent to have each fee category reviewed by a qualified Korean franchise transaction specialist or lawyer, and to agree the tax treatment with a tax professional.

5. Validate the structure with a one-page fee schedule before the first invoice

Finally, prepare a fee summary that prospective franchisees can understand. For each item, state the amount or formula, what it covers, when payment is due, the circumstances that trigger additional charges and the refund conditions. This table is an aid to explaining a complex fee structure, not a substitute for legally required documents.

Give a staff member a fictional set of monthly transactions and ask them to prepare an invoice. Check whether another staff member reaches the same result, and whether there are rules for handling refunds or temporary closures. Fee changes must also be reviewed against existing contracts and applicable law. Updating an internal price list does not, by itself, allow you to impose the new charges immediately on existing franchisees.

Practical takeaway: Before setting franchise fees and royalties, prepare a support cost schedule, a calculation of the financial burden on franchisees and a fee summary. When all three documents describe the same structure, you are closer to a fee system that both the franchisor and franchisees can sustain.