A royalty is an ongoing payment from a franchisee to a franchisor, in exchange for the continued right to operate under the brand and for the support that comes with it. It is normally calculated as a percentage of sales and paid weekly or monthly.
It is the economic centre of the relationship. The initial fee is paid once. The royalty is paid for as long as the agreement runs, which means it is the thing that has to be worth paying in year six as well as year one.
The basis matters more than the rate
Two systems quoting the same percentage can produce very different obligations, because the percentage is applied to something, and what that something is varies.
- Gross sales is the most common basis. Everything the business invoices, before any deduction.
- Net sales, where defined, deducts specific items such as refunds or sales tax. What is deductible is defined in the agreement, not by convention.
- A fixed periodic fee, less common in service franchising, which does not move with volume at all.
- A minimum royalty, which sets a floor regardless of what the business actually invoices.
That last one is the item most often missed. A minimum converts a variable cost into a fixed one during exactly the periods when a business can least carry it. Whether a system has one, and what it is, is disclosed.
What the royalty is supposed to buy
A royalty is not rent on a logo. It is payment for the continued obligations the franchisor carries, and those obligations are disclosed in their own item of the disclosure document. What a franchisor owes an operator sets out what that ought to include.
The test is not whether the rate is low. It is whether what the franchisor is obliged to do in return is worth it, and whether that obligation is written as a requirement rather than as a discretion. A cheap royalty attached to no commitment is not cheap.
The marketing fund is a separate question
Most systems also collect a marketing or brand fund contribution, separately from the royalty and usually also as a percentage of sales. It is pooled and spent at the brand level. Ask what it may be spent on, whether the franchisor contributes to it, and whether it is accounted for. All of that is disclosed alongside the rest of the fee structure.