Franchise Royalties: How to Check the Terms Before You Buy

Two brands charging the same royalty rate can impose very different financial burdens on a franchisee. It all depends on which receipts count, when royalties start accruing and whether the franchisor can change the rules. Transparent calculations underpin predictable relationships within a franchise network. Before buying a franchise, check not just the percentage quoted in the presentation, but the entire contractual framework for recurring payments.

1. Establish what you are paying for and when payments begin

Russia has no standalone franchising act, but Chapter 54 of the Russian Civil Code specifically regulates commercial concession arrangements, the legal framework commonly used for franchising. Article 1030 allows various forms of remuneration: fixed one-off or recurring payments, a share of revenue and other agreed options. The word ‘royalty’ alone therefore defines neither the calculation method nor the scope of your obligations.

A commercial concession agreement must be made in writing between commercial organisations or individual entrepreneurs. Under Article 1028 of the Russian Civil Code, it is the grant of the right to use a package of exclusive rights, rather than the agreement itself, that must be registered with Rospatent, Russia’s intellectual property authority. Without registration, the rights are deemed not to have been granted.

Distinguish three events in the documents: signing the agreement, registering the grant of rights and opening the outlet. Clarify which one triggers royalty accrual. If payments become due immediately after signing, they may accumulate during fit-out, before you have made any sales.

Ask for separate provisions covering delays to opening caused by you, by the rights holder or by circumstances for which neither party is responsible. Do not assume payments will automatically be deferred. You should also agree the treatment of royalties before registration, and the consequences of non-registration, with legal advice rather than relying on a manager’s promise to ‘recalculate it later’.

2. Clarify the calculation basis for every potentially disputed transaction

The key question is what the agreement means by revenue. This could be money received into your business bank account, the value of paid orders, sales recorded at the till or a figure from your accounting system. These figures do not always match. The phrase ‘a percentage of turnover’, without a definition, leaves too much room for dispute.

Check how the following are treated:

• VAT: is it excluded from the calculation basis if you are required to charge it?
• Refunds: do they reduce the calculation basis, and in which reporting period?
• Discounts and loyalty rewards: is the actual selling price used, or the price before the discount?
• Advance payments and gift vouchers: does the royalty accrue when payment is received or when the goods are supplied?
• Sales through aggregator platforms: does the calculation use the full order value or the amount received after deductions?
• Delivery: is the delivery charge included if the payment goes through your till?
• Unrelated receipts: are loans, capital contributions from the owner and transfers between your own accounts excluded?

For example, a customer pays for an order through an aggregator, which transfers the money to you after deducting its commission. If the calculation basis is defined as the full sales value, the commission will not reduce the royalty. This is not necessarily an inappropriate term, but you need to understand it before buying, not after the first reconciliation.

Pay particular attention to gift vouchers: receiving an advance payment and subsequently redeeming the voucher should not inadvertently trigger royalties twice. Prepare a few sample transactions and ask the franchisor to calculate the payment in writing. It is useful to include the agreed examples in a schedule to the agreement, alongside the formula.

3. Check minimum payments and the rules for increases

Royalties may be fixed, percentage-based or a combination of the two. A clause requiring ‘a percentage of revenue, subject to a specified minimum’ means that a minimum payment is compulsory even when sales are weak, unless the agreement provides exceptions. That payment may still apply when revenue is zero.

Find out how payments are calculated for a partial month of trading. Check what happens during temporary closure, refurbishment, seasonal downtime or a suspension of operations. If there is an introductory concession, specify its duration, start date and the conditions under which it can end early. The phrase ‘start-up concession’ is of little use without these details.

Separately, identify every basis on which payments can change. In business-to-business relationships, an agreement may allow unilateral changes to its terms within certain limits. You should therefore not assume that any clause allowing an increase is automatically invalid.

During negotiations, propose clear limits:

• an exhaustive list of grounds for revision;
• the frequency and maximum size of increases, or a verifiable indexation formula;
• advance written notice;
• application of the new rate to future periods only;
• a prohibition on changing the calculation basis by updating internal rules.

Check other recurring charges too, including marketing, technology and administration fees. It is important to avoid a situation where a promise that ‘royalties will not increase’ is accompanied by new compulsory charges.

4. Agree a process for reconciliation and correcting errors

Russia has no universally mandatory pre-contractual franchise disclosure document comparable to those required in some other jurisdictions. You should therefore request the draft agreement, schedules and fee schedule yourself, before making any payment. General rules on good faith in negotiations, including Article 434.1 of the Russian Civil Code, are no substitute for an agreed calculation formula.

The agreement should specify the data source, reporting period, deadline for submitting reports and payment date. If till records and accounting system data differ, there should be a verification procedure rather than automatic acceptance of one party’s calculation.

Agree a deadline for raising objections, a list of supporting documents and a method for correcting errors. Specify when overpayments will be refunded or credited, how shortfalls will be paid and what happens if payment is late. If the franchisor has audit rights, limit access to the information needed for the audit and include confidentiality provisions.

Practical takeaway: before buying a franchise, make sure you can calculate the royalties yourself using the agreement and your sales data. If the answer depends on a manager’s verbal explanation, the terms still need work.