Buying a franchise: check how the royalty is calculated

A franchise fee may seem straightforward: you pay a percentage of your turnover to operate within a franchise network. But what exactly counts as turnover, when must you pay, and is there a minimum fee? Clear financial arrangements underpin a workable franchise relationship. Before buying a franchise, look beyond the headline percentage and examine the rules used to calculate the royalty.

1. Establish what you pay royalties on

The ongoing franchise fee is often called a royalty. It may be a fixed amount, a turnover-based amount or a combination of the two. The percentage alone is therefore not a reliable basis for comparing franchise opportunities.

Start with the definition of turnover in the draft agreement. If it refers only to ‘turnover generated’, ask for a detailed explanation. At a minimum, check the following:

• VAT: is the fee calculated on turnover excluding or including VAT?
• Discounts: does the calculation use the original selling price or the amount the customer actually pays?
• Returns: are refunds deducted, and in which accounting period?
• Gift vouchers: does turnover count when the voucher is sold, when it is redeemed or at another point?
• Unpaid invoices: do you also pay royalties on amounts customers have not yet paid?
• Platform sales: does the calculation use the full amount paid by the customer or the amount after platform fees have been deducted?

The word ‘royalty’ does not automatically answer any of these questions. The agreement must make the applicable calculation sufficiently clear. In particular, make sure the same sale cannot be counted twice, for example when a gift voucher is both issued and redeemed.

Also ask which documents govern the calculation. Additional rules may appear in the operations manual, a fee schedule or the terms governing the point-of-sale system. Have any inconsistencies resolved before signing.

2. Test the fee with a sample calculation

Ask the franchisor for a worked example invoice and the underlying turnover data. Then have your accountant perform the same calculation independently. If the results differ, the definitions need to be clarified.

Do not test only a typical trading month. Also look at an opening month with low turnover, a month with a high volume of returns and a period with substantial promotional discounts. This will show how the arrangement affects your business when trading differs from the average.

Pay particular attention to any minimum fee. If a minimum amount is always payable, the effective royalty rate at low turnover levels may be much higher than the quoted percentage. Always calculate the total royalty divided by the turnover figure you use in your own business analysis.

Check any tiered rates too. Once you reach a turnover threshold, does a lower rate apply to all turnover or only to the amount above that threshold? Is the threshold assessed monthly, quarterly or annually? Is there a subsequent adjustment? A tiered structure without clear calculation rules can lead to persistent differences in interpretation.

3. Examine payment timing and adjustments

The calculation determines how much you pay; the payment schedule determines when that money leaves your account. Ask whether the franchisor uses advance payments, direct debits or invoices issued in arrears. Specify when a final reconciliation will take place and how overpayments will be refunded or credited.

Next, check how errors are corrected. Who handles a query or dispute over a royalty statement? What supporting data will you receive? How long do you have to respond? Do not assume that disputing an invoice automatically suspends your obligation to pay; have the contractual provisions reviewed by a legal adviser.

Also examine indexation and fee changes. Indexation provisions should specify an identifiable index, a reference date and a calculation method. Any right to change fees should be subject to clear conditions and procedures. Seek advice on whether the variation clause is valid and what statutory protection applies in your circumstances.

Finally, ask what the royalty covers. A fee may be less attractive if essential systems or services carry separate charges. Draw up a single overview showing the royalty and which services and support it does and does not cover.

4. Use your statutory right to information

In the Netherlands, the Franchise Act has been in force since 1 January 2021 and is incorporated into Book 7, Title 16 of the Dutch Civil Code. Before the agreement is concluded, the franchisor must provide information including the fees, mark-ups and other financial contributions you will have to pay, as well as the investments required.

The legally required information must be available at least four weeks before the franchise agreement is concluded. Use this period to have the royalty calculation checked as well. You also have a duty to investigate: take reasonable steps to avoid signing on the basis of incorrect assumptions.

The law does not prescribe a standard royalty or a maximum percentage. Protection therefore starts with transparent information and carefully documented terms. Have any verbal promises about exemptions, introductory discounts or alternative calculations included in the agreement or a signed appendix.

Practical conclusion: sign only when you can independently arrive at the same royalty figure as the franchisor using the same turnover data. A calculation you can verify is worth more than an attractive percentage without clear terms.