FRANCHISE LAW
How Franchise Royalty Fees Work
A franchise royalty is the ongoing fee a franchisee pays for the right to keep using your brand and system — most often a percentage of gross sales, collected on a set schedule, backed by reporting and audit rights, and disclosed in Item 6 of your Franchise Disclosure Document (FDD). How you structure and document that royalty determines whether it funds your system reliably or becomes a recurring fight over what counts and when it is due. This is how franchisors should think it through.
The Royalty Models
There are four common ways to structure an ongoing royalty. Many systems combine them — most often a percentage with a minimum floor.
| Model | How it works | Best when |
|---|---|---|
| Percentage of gross sales | A set percent of revenue, paid weekly or monthly | The most common model; scales with the franchisee’s volume |
| Flat/fixed fee | A fixed dollar amount per period regardless of sales | Sales are hard to track or vary little; gives predictability |
| Tiered | The percentage changes as sales cross thresholds | You want to reward (or share in) growth |
| Minimum royalty | A floor the franchisee pays even in slow periods | Protects baseline revenue; usually paired with a percentage |
The percentage-of-gross-sales model dominates because it aligns your revenue with the franchisee’s: when the unit does well, you do well. Royalty rates vary widely by industry and are commonly a single-digit percentage of gross sales, but there is no legal “standard” rate — what matters is that the number is disclosed and defensible against the support you provide.
Define “Gross Sales” Precisely
The most litigated word in a royalty clause is “sales.” Define your royalty base in detail and leave nothing to interpretation:
- What is included — all revenue from the unit, typically including cash, card, online orders, gift-card redemptions, and catering or delivery.
- What is excluded — sales tax collected for the government, bona fide refunds, and sometimes third-party delivery commissions (decide and state it).
- When it is counted — at the time of sale, not when the franchisee is paid.
A tight definition prevents the slow leak that happens when franchisees exclude categories you assumed were covered.
Reporting, Payment, and Audit Rights
A royalty is only as good as your ability to verify it. Three mechanics make it enforceable:
- Reporting. Require franchisees to report gross sales on a fixed cadence — usually weekly or monthly — in the format and system you specify. Tie reporting to your point-of-sale system where possible so the number comes straight from the register.
- Payment. Set the method (typically electronic funds transfer on a fixed day), and make late payments carry interest or a late fee so paying on time is the cheaper option.
- Audit. Reserve the right to inspect the franchisee’s books and to audit. Add teeth: if an audit reveals an underpayment over a stated threshold (a common figure is 2%), the franchisee pays for the audit and the shortfall, with interest. The audit clause is what keeps the reporting honest.
Connect the Royalty to Item 6 — and to What You Deliver
Every recurring fee belongs in FDD Item 6, the “other fees” table: the royalty, the advertising or brand-fund contribution, and event-driven fees like transfer, renewal, technology, and audit charges. Item 6 has to match the agreement exactly — same rates, same timing, same calculation. The initial franchise fee, by contrast, sits in Item 5.
There is a substantive point underneath the disclosure. The royalty has to be justified by the support you provide, which you disclose in Item 11. A high ongoing royalty paired with thin support is the mismatch franchisees challenge and regulators question. The fee, the disclosure, and the actual service all have to align.
Advertising Funds Are Not Royalties
Keep the brand or advertising fund separate from the royalty in both the agreement and your accounting. Advertising-fund contributions are generally collected to be spent on system marketing, and franchisees expect — and many state laws and your own disclosures require — that the fund be accounted for and used for that purpose. Commingling ad-fund money with general royalty revenue is a frequent source of franchisee claims. Disclose how the fund is administered and report on its use.
Frequently Asked Questions
How much should a franchise royalty be?
There is no legally fixed rate. Royalties are commonly a single-digit percentage of gross sales but vary widely by industry and by how much ongoing support the franchisor provides. The right number is one you can disclose in FDD Item 6 and justify against the value and support franchisees receive.
What counts as “gross sales” for royalties?
Whatever your agreement defines it to be — which is why the definition matters. Most franchisors include essentially all unit revenue and exclude only sales tax and bona fide refunds. Spell out inclusions, exclusions, and the timing so the base cannot be argued.
Can a franchisor audit a franchisee’s sales?
Yes, if the agreement reserves the right — and it should. A standard clause lets the franchisor inspect records and audit, and shifts the audit cost to the franchisee if an underpayment over a set threshold is found. Audit rights are what make self-reported royalties trustworthy.
Where are royalty fees disclosed in the FDD?
Ongoing royalties and other recurring or event-driven fees go in Item 6 (“other fees”); the one-time initial franchise fee goes in Item 5. The fees in the FDD must match the fees in the franchise agreement exactly.
Setting your royalty structure for a new franchise system, or tightening the reporting and audit terms in an existing one? Reidel Law Firm helps franchisors structure compliant fees and disclosures. Talk to a franchise attorney about going to market. For the full picture, see key clauses every franchise agreement needs.
