What Are Franchising Royalties? (2025 Updated)

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When a franchise is bought in New Zealand, there is typically an upfront fixed fee that is paid in a lump sum to the franchisor. This fee essentially covers the set-up costs, the initial services provided by the franchisor, the value of the intellectual property, and the expenses associated with training and ongoing support.

However, when joining or selling a franchise, it is important to remember that this investment comprises a variety of components. One initial payment does not secure the right to operate the franchise without further contributions throughout the lifetime of the business.

The Franchise Agreement will determine the specific amounts to be paid. An agreement to purchase a franchise usually includes provisions for ongoing payments for the continued use of the intellectual property and brand identity. In recent years, particularly moving into 2025, many agreements have also incorporated digital support platforms and enhanced training modules that reflect the modernisation of the industry.

These ongoing payments are called royalties.

What Are Royalties?

Unlike upfront payments, royalties are paid on an ongoing basis for the continuous use of a franchise’s assets. For instance, an author might receive royalties for every sale of their book, while a franchisee pays regularly for the established brand and support services.

For franchisees, royalties typically cover head office expenses – which can include administration, advertising, technical support, and continuous legal advice – as well as payment for the franchise business concept and brand value. This detailed breakdown ensures that both parties are clear about what each payment contributes towards.

The brand recognition of a global name like McDonald’s is almost impossible to replicate independently. When you buy a McDonald’s franchise, you benefit from immediate recognition that can drive sales and customer trust. Franchise royalties help sustain this recognition through continuous investment in brand development and modern marketing strategies.

In summary, royalties are designed to cover the costs associated with maintaining the brand and infrastructure that franchisees benefit from every day.

Why Are Franchise Royalties Important?

At first glance, it might appear that franchise royalties solely benefit the franchisor’s brand and business; however, this is not entirely the case. Royalties are crucial to the success of the overall franchise network, and therefore, to the individual franchisee. If the brand suffers from neglect or financial difficulties, the individual franchisee is also likely to be adversely affected.

Most franchisors reinvest a significant portion of the royalties they earn into the maintenance and development of the brand. This reinvestment may include:

Innovative and attractive new products
Development and maintenance of cutting-edge technology
Day-to-day management and operational support
Retention of key staff and expert consultants
Extensive and modern advertising campaigns

Ultimately, much of what the royalties are spent on benefits the franchisee. However, the amount set for royalties must be calculated fairly to balance the interests of both parties. To explore further details about the legal aspects of franchise setups, you might consider reading our Business Partners Guide or our Legal Tips section.

How Are Franchise Royalties Calculated?

As you might expect, these fees differ according to the specific franchise. Each franchise royalty is tailored to the distinctive features and requirements of the business on offer. In reviewing a franchise agreement – a process we recommend undertaking with professional advice from our team – you can ensure that the agreed percentage is fair and sustainable.

Typically, the most common method requires a franchisee to pay between 4% and 8% of their gross sales each month. However, some agreements, particularly those designed to protect the franchisee’s interests, might calculate this percentage based on net sales – that is, sales minus expenses incurred – offering a greater level of protection.

Royalties are generally calculated on a monthly or quarterly basis, though some agreements may stipulate an annual calculation, particularly for franchises with seasonal fluctuations. For more information on the legal requirements involved, check out our Legal Requirements for Starting a Business guide.

Other Types Of Franchising Royalties

There are numerous methods for calculating franchise royalties, each designed to reflect the nature of the business. As legislation and market conditions have evolved into 2025, some franchise agreements have adapted flexible royalty structures to ensure fairness and mutual growth.

Leniency Period

A franchise agreement might include an initial leniency or ‘adjustment’ period during which the franchisee pays a reduced royalty fee. For example, there might be a reduced rate of 4% for the first four months, increasing to 8% once the business is fully operational. This helps new franchisees stabilise their cash flow.

Some agreements may stipulate a fixed royalty fee, providing the franchisor with a set income each period irrespective of sales volume. For instance, an agreement might charge a fixed fee of $10,000 per month for the use of the franchisor’s intellectual property.

Minimum Royalty

Another common method is the minimum royalty. This approach ensures that the franchisee pays the higher of either a fixed minimum amount or the calculated monthly percentage royalty. However, it is important to negotiate this carefully, as such arrangements can become burdensome during slower periods.

Variable Percentage Of Gross Sales

The royalty may also be structured as a variable percentage of gross sales. For example, a franchise might have a tiered system where the percentage decreases as total gross sales increase, thereby rewarding better performance. Alternatively, higher percentages might be applied for premium locations with superior sales performance. This flexible structure can provide a fairer system, encouraging growth and recognising market conditions.

Transaction-Based Royalty

Lastly, depending on the particular franchise, a transaction-based royalty might be appropriate. For example, a hotel chain franchise may require payment for each booked reservation rather than a percentage of gross sales. However, this fee structure is generally less common in industries such as fast food, where sales volumes are high and transactions occur frequently.

All these methods depend on the specific terms of the franchise agreement and the nature of the franchise. For additional insight into drafting fair agreements, you can refer to our article on setting out good business terms & conditions.

The Key Aspect Of Franchising Royalties

Having a thorough understanding of the business you are buying or selling is crucial to determining the appropriate franchise royalties. A sound royalty structure not only protects the franchisor’s brand but also ensures that the franchisee retains a healthy profit margin.

If a franchisor provides extensive training, administrative support, and ongoing legal assistance, the corresponding royalty should reflect these benefits without unduly burdening the franchisee. Similarly, if a franchisee is required to pay an exorbitant royalty for minimal support, this could hinder the business’s growth and sustainability.

Both the franchisee and franchisor want the franchise—and their business relationship—to succeed. A successful franchise model in 2025 incorporates modern digital tools, enhanced support systems, and flexible contractual terms that adjust to market conditions; for further guidance on staying updated with industry changes, see our Industry Regulations Guide.

It might be tempting for a franchisor to protect their own interests by imposing high royalties, but to foster a thriving business, the fee should be set at a level that allows the franchisee to earn sufficient revenue after all expenses are deducted.

As explored above, there are numerous ways to structure these payments. It all depends on the industry type and the specific needs of the franchise.

Franchising Resources

Franchising law can be complex, and it is an area that requires expert legal guidance. We have a range of resources to assist you through various stages of the franchising process, such as:

Need Help?

It is crucial to have a lawyer review your franchise agreement and the terms around royalties. This review will help secure the future profitability of your business relationship.

If you are thinking about buying or selling a franchise, reach out to our team for a free, no-obligations chat about franchise royalties at [email protected] or on 0800 002 184.

Will Tinney

Will is currently completing his Juris Doctor at the University of Melbourne and is interested in helping to provide equitable and efficient access to legal resources.

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