Franchise royalty fees explained

A franchise royalty fee is the ongoing payment a franchisee makes to the franchisor for the right to use the brand, recipes, systems and support. In most US franchise systems it is a percentage of gross sales, paid weekly or monthly. Many restaurant brands charge somewhere around 4% to 8%, though the range is wide.

Most systems also charge a separate ad fund or marketing fund fee, often a few percent of gross sales on top of the royalty. Because both come off sales before food, labor or rent, they are owed in good months and bad ones. That is the single most important thing to understand about royalties: they scale with sales, not with profit.

This guide describes how royalties generally work in the US. It is not legal advice. Your franchise agreement is the document that counts, so check it and talk to a franchise attorney or accountant before you sign anything.

How franchise royalties work

A royalty is a license fee. You pay the franchisor for the brand name, the operating system, training, purchasing programs and ongoing support. The franchise agreement sets the rate, what it is charged on, and when it is paid.

Most royalties are charged on gross sales. The agreement defines what that means. It usually excludes sales tax collected from customers. Beyond that, definitions vary. Some include delivery sales at the full menu price before the delivery app takes its commission. Some treat catering, gift card sales or employee meals differently. Read that definition closely, because it decides how much you pay on every order.

Payment is often by automatic bank draft, weekly or monthly, based on sales reported from the POS. Many franchisors now read POS data directly.

Common royalty structures

• Fixed percentage. The most common. The same rate on every dollar of gross sales, such as 6%.
• Tiered or stepped percentage. The rate changes at certain sales levels, or steps up over the first years of the agreement.
• Flat fee. A fixed dollar amount per week or month, whatever the store sells. Less common in restaurants.
• Minimum royalty. A percentage with a floor, so a slow store still pays a minimum amount.

What is the ad fund or marketing fund fee?

The ad fund fee pays into a shared pool the franchisor uses for brand advertising: national or regional campaigns, digital ads, creative and the brand's app or website. It is separate from the royalty and usually also a percentage of gross sales.

Many agreements also require a local marketing spend. That is money you spend yourself in your own market, and it is in addition to the ad fund. Item 11 of the FDD describes how the advertising fund is managed and whether the franchisor reports on how it was spent.

Other ongoing fees often sit alongside these: technology or software fees, POS support fees, training fees for new managers, transfer fees, renewal fees, audit fees and interest on missed payments. Add them all up before you compare brands.

Where to find royalty fees in the FDD: Item 6

Under the FTC Franchise Rule, a franchisor must give you its franchise disclosure document at least 14 calendar days before you sign a binding agreement or pay any money. The FDD has 23 items. The ones that matter most for ongoing fees are:

• Item 5, Initial Fees. The upfront franchise fee.
• Item 6, Other Fees. Every recurring fee, including the royalty and ad fund, with the amount, due date and notes.
• Item 7, Estimated Initial Investment. The cost to open.
• Item 11, Franchisor's Assistance. Includes how the advertising fund works.
• Item 19, Financial Performance Representations. Sales or profit data, if the franchisor chooses to give it.

To judge whether the fees are worth it, put Item 6 next to Item 19. Our guide on how to read Item 19 walks through it.

Worked example: what royalties cost a store

Here is a month at Switchback Grill in Cheyenne, a fictional burger franchise with a 6% royalty and a 2% ad fund fee.

Now put those fees in the store's P&L.

Before fees, the store made $24,000. The fees took $9,600 of it, or 40%.

Now take a slow month. Sales drop to $100,000. Food and paper falls with sales to $30,000. Labor only comes down to $33,000, because a store still needs a crew to open. Rent stays at $9,000 and other costs barely move, to $14,000. Profit before fees is $14,000. Fees are 8% of $100,000, or $8,000. Profit after fees is $6,000, or 6.0% of sales.

Sales fell by $20,000. Fees fell by only $1,600. Profit after fees fell by $8,400. In the slow month the fees took 57% of the store's pre-fee profit, up from 40%. That is the squeeze. Our guide on how to read a restaurant P&L shows where to find each of these lines.

How royalties apply to delivery and catering sales

The definition of gross sales matters most on delivery. Take a $30 order on a delivery app with a 25% commission. Commission rates vary by app and plan, so use yours.

If your agreement charged fees on the $22.50 the app actually paid, the fees would be $1.80 instead of $2.40. Sixty cents is small on one order and real across thousands. Our guide on making third-party delivery profitable covers the rest of that math.

Catering usually carries the full royalty too. It is still one of the better ways to grow sales, because a large order spreads the same crew and rent across more dollars. See how to grow catering sales.

Common mistakes with franchise royalty fees

• Comparing only the royalty rate. A 5% royalty with a 4% ad fund costs more than a 6% royalty with a 2% ad fund.
• Forgetting technology and other recurring fees in Item 6.
• Budgeting fees as a share of profit. They come off sales.
• Modeling fees only at the sales you hope for. Run the numbers at 20% lower sales too.
• Skipping the definition of gross sales, especially for delivery, catering and gift cards.
• Assuming terms can change after signing. Assume they cannot.

A simple weekly habit for royalty-paying stores

Every Monday, take last week's gross sales from the POS and multiply by your total fee rate. Set that cash aside so the draft never surprises you. Then compare the week's sales with the same week last year and with the weeks before. Because fees scale with sales while rent and much of labor do not, the habit that protects profit is growing sales: catering, add-ons, more orders. Our guides on prime cost and break-even point show where your floor sits.

Franlever's AI COO compares each store with its own recent weeks and with the middle store in its brand, and each morning sends the owner at most one specific lever per store, aimed at sales, labor or reviews. A store running normally gets no lever that day. See how Franlever works.

General information for restaurant and franchise operators, not legal, tax, accounting or financial advice. Figures in examples are illustrations, not predictions or promises of results. Laws and platform policies change and differ by location, so check the current rules and talk to a qualified advisor about your situation.