Initial Franchise Fees and Royalties: How to Calculate Franchise Payments

A profitable existing business does not necessarily have a viable franchise fee model. A company-owned outlet does not pay royalties, and the founder’s time is often left out of the costs altogether. Before recruiting franchise partners, you need to assess the economics on both sides: how much it costs to support a franchisee, and how much they can afford to pay without undermining the viability of their business.

1. Separate launch costs from ongoing support costs

Start with a list of your obligations to the franchisee, rather than your competitors’ prices. For each activity, identify who will carry it out, the time required, the direct costs and the deliverable. This will reveal which costs are one-off and which recur regardless of whether new franchisees join the network.

The budget for launching a franchisee’s business may include:

• assessing the premises and approving the layout;
• training the owner, manager and initial team;
• setting up accounting and operational systems and user access;
• helping with purchasing and preparations for opening;
• sending a specialist to the site for the launch.

Your ongoing budget should include advice, quality checks, updates to materials, software support and the work of a franchise support manager. Assess the management team’s shared overheads separately: these cannot be allocated entirely to one outlet, but nor can they be ignored.

Franchisee recruitment is also a cost: advertising, negotiations and vetting candidates all require resources. However, factoring these costs into your pricing does not make them a separate service for the franchisee. Do not present costs that actually fund your sales process as benefits within a start-up package.

If the founder is still supporting franchisees personally, value their time at the cost of hiring a specialist to replace them. Otherwise, the model will appear profitable only until the first hire.

2. Calculate the initial franchise fee based on your obligations

The initial franchise fee is generally understood to be a one-off payment at the outset. Its purpose and scope must be defined in the agreement: it may be consideration for granting a package of rights, cover an agreed start-up package, or combine both elements. You should not automatically treat every initial fee as payment for training alone.

For internal calculations, use the following guide:

Start-up costs per franchisee + a share of recruitment and preparation costs + a contingency allowance + target profit.

This is a management formula, not a statutory tariff. The market value of the brand and its technology also influences the price, but does not remove the need to check your costs. Compare the final amount with the rights, support and benefits the franchisee will actually receive.

Prepare a schedule to the agreement defining the limits of the start-up package. How many employees will be trained? Who pays for travel and accommodation? Is a repeat site visit included? What happens if the premises change? These details protect both parties better than an undefined promise of a ‘turnkey launch’.

If payment is staged, link each instalment to a clear milestone. Separately agree what happens if the project is halted: what has already been delivered, which costs can be substantiated and how any refund will be calculated. Stating that ‘the fee is non-refundable under all circumstances’ does not, in itself, eliminate legal risks.

3. Choose a royalty model and test the economics on both sides

Royalties should reflect the support model while remaining affordable for the outlet. Compare several options before choosing the one that is most convenient for the management team.

A fixed fee makes planning easier, but puts greater pressure on the franchisee during seasonal sales downturns. A percentage of revenue moves in line with turnover, but requires a precise definition of the calculation base. A combined model may include a minimum fee and a variable component, but needs particularly careful testing under low-sales conditions.

For a percentage-based model, specify in writing:

• whether the calculation uses cash receipts or recorded sales;
• how returns, discounts, advance payments and gift vouchers are treated;
• whether VAT is included in the calculation base;
• whether sales through intermediaries are counted before their commission is deducted;
• how delivery and online orders are treated.

Next, recalculate the finances of your own outlet as though it belonged to a franchisee. Add royalties, the salary of an employed manager, compulsory advertising expenditure, software costs and other network charges. Test a normal month, the launch period and a scenario in which revenue falls. Assess not only profit, but also the cash remaining after taxes, loan repayments and essential purchases.

At the same time, test the franchisor’s economics: will recurring income cover the promised support at a realistic number of operating franchisees? If support for existing outlets is funded solely by fees from new entrants, the model needs to be revised.

4. Formalise the payment model under Russian law

In Russia, commercial concession arrangements—the legal framework used for franchising—are specifically governed by Chapter 54 of the Civil Code of the Russian Federation. Article 1030 permits various forms of remuneration, including fixed one-off or periodic payments and payments calculated as a share of revenue. The law does not require an initial franchise fee and royalties to be charged together.

Commercial organisations and registered individual entrepreneurs may be parties to a commercial concession agreement. Under Article 1028, the agreement must be in writing, and the grant of the right to use a package of exclusive rights must be registered with Rospatent, Russia’s intellectual property authority. Without registration, the grant of rights is deemed not to have taken place; this is not the same as the signed agreement automatically being invalid.

Agree with a lawyer when fees will begin to accrue, the registration timetable and the consequences of delays. Specify the calculation period, payment date, reporting requirements, reconciliation procedure and permitted mechanism for changing prices. Ask an accountant to check the tax treatment of each payment: calling a payment a ‘royalty’ does not, by itself, determine its tax treatment.

Show advertising levies and compulsory additional purchases separately. If you collect contributions to a shared advertising fund, set out the permitted uses and the arrangements for reporting to franchisees.

Practical takeaway: before selling your first franchise, prepare a launch cost calculation, an ongoing support budget and a franchisee cash flow model. Set fees only once all three calculations align with specific contractual obligations.