Franchise royalties: how to check the calculation before you buy

A low royalty rate does not necessarily mean a franchise offers good value. The final payment depends on which sales count towards the calculation, when the obligation to pay arises and which exclusions the agreement allows. Before joining a franchise network, a prospective franchisee should check not only the recurring fee but also the full calculation method. Here are the documents to request and the terms to agree before signing.

1. Identify the fee structure

In Russia, commercial concession arrangements are governed by Chapter 54 of the Russian Civil Code. Article 1030 allows various forms of remuneration: fixed one-off or recurring payments, a share of revenue, a mark-up on the wholesale price of goods supplied for resale, and other agreed forms. There is therefore no single statutory royalty rate: the agreement defines the specific payment obligation.

A commercial concession agreement must be in writing, and the grant of the right to use the bundle of exclusive rights must be registered with Rospatent, Russia’s intellectual property office, under Article 1028 of the Russian Civil Code. Without registration, the rights are deemed not to have been granted. This matters when agreeing the date from which fees start to accrue, but registration itself is no substitute for checking the payment formula.

Ask the franchisor to set out the calculation method as one clear rule. It may involve a fixed amount, a percentage of an agreed calculation base, or a combination of the two. Pay particular attention to any minimum payment: wording such as ‘a percentage, subject to a minimum amount’ means that when sales are weak, the effective charge as a proportion of revenue rises.

Also check whether several fees apply in parallel under different names. A support fee may be charged separately from royalties, even if the sales presentation describes support as included.

2. Define the calculation base

Terms such as ‘turnover’, ‘income’ and ‘revenue’ leave room for disagreement unless they are defined. Do not automatically assume that the contractual calculation base matches receipts into your business bank account, figures in your financial statements or income recognised for tax purposes.

Ask for a list of the transactions included in the calculation to be added to a schedule to the agreement. It should answer at least the following questions:

• Is VAT included in the calculation base where it is charged to customers?
• Are advance payments counted when received or only once the order has been fulfilled?
• When does the sale of a gift voucher enter the calculation base, and how is double counting avoided when it is redeemed?
• How are cancellations, returns and partial refunds treated?
• Are customer-paid delivery charges included, and does it matter who provides the delivery service?
• Are sales through intermediaries counted before or after commission is deducted?

Check the last two points particularly carefully. If an intermediary transfers funds after deducting its commission, that does not necessarily mean royalties are calculated on the amount received. The agreement may provide for royalties to be charged on the full order value. This is not inherently wrong, but the prospective franchisee needs to understand the implications in advance.

Define separately which sales are attributed to a particular outlet. For example, an online order may be paid for centrally but fulfilled by the franchisee. Without an allocation rule, there is a risk of royalties being charged twice or a dispute over which outlet the revenue belongs to.

3. Check the payment and adjustment timetable

The date from which fees start to accrue should not be buried in the agreement’s general provisions. It may be an agreed calendar date, the opening of the outlet or another clearly defined event. Clarify what happens if the first month is incomplete: is the fixed fee charged in full or pro rata for the period of operation?

Next, agree the reporting period, the deadline for submitting data, the payment date and the procedure for correcting errors. It can be useful to separate the provisional calculation from the final reconciliation if information from intermediaries arrives later than till data.

A customer refund may occur after royalties have already been paid. It is therefore not enough simply to state that refunds are excluded from the calculation base. There needs to be a mechanism: a reduction in the next period’s payment, a recalculation or a refund of the overpayment. Specify the supporting documents required and the deadline for making the adjustment.

VAT on the franchisor’s fee is a separate issue. The wording should make clear whether any applicable tax is included in the agreed fee or charged on top. This is distinct from excluding VAT from the franchisee’s sales calculation base. Check the tax implications of the particular arrangement with an accountant.

4. Agree data sources, reconciliation and rate changes

Before buying, request a sample monthly report and an anonymised example calculation. Then work through several scenarios with the franchisor: a standard sale, an order through an intermediary, a refund in the following month and the redemption of a gift voucher. It is better to record the agreed treatment in a schedule to the agreement than leave it in correspondence with a sales manager.

It is useful for the agreement to specify:

• the data source for each category of sales;
• what happens if the till report and accounting system show different figures;
• the deadline for reviewing the report and submitting reasoned objections;
• the procedure for correcting the calculation and crediting any overpayment;
• how the undisputed amount is to be paid.

Check whether the franchisor can change the rate, minimum payment or calculation base unilaterally. A reference to current fee schedules without a clear mechanism for changing them makes future costs less predictable. Discuss the grounds for revisions, how often they can occur, limits on changes and advance notice. Do not assume that every unilateral increase is automatically unlawful: the terms of the business agreement and the applicable provisions of the Russian Civil Code matter.

Practical takeaway: before buying, make sure that you and the franchisor arrive at the same payment amount using the same set of figures. A clear formula, charging timetable and adjustment procedure offer better protection than an attractive rate with no explanation.