Franchise Articles -
How To Determine The ROI Of A Franchise Opportunity
Franchise Return on Investment
How do you find a franchise with great returns?
A wise investor, whether he puts money in the stock market or real estate or even collectible figurines, always considers the return he can expect on his investment. This should also be true of franchise investments. Those investigating franchise opportunities should look carefully at the company’s potential ROI. However, since a franchise purchase involves investments of both time and money, you should expect more than you would from a passive investment.
Returns of 10% to 15% per year on invested capital are normally considered to be very good by those investing in a passive opportunity. If you invested $100,000 in the stock market and earned $15,000, you’d be pretty happy. To make more money, you’d have to invest more money. Most people accept the general fact that the more money you invest, the more money you’ll get back.
However, your expectations for a return on a franchise investment should be vastly different. In a franchise investment you are investing a fair amount of your time and management talent in addition to your capital. You should be able to achieve a good return on both investments.
The second assumption people often make is that the less money you invest for a franchise the less money you will earn, and the higher your investment amount in a franchise opportunity the higher your return. Actually, there is often little correlation between the total investment and the amount of money you can make in the business. Returns in franchising vary all over the board, depending on the concept, the industry, the market and the operator.
A common element for boosting ROI is to use leverage to increase the return. Typically, leverage relates to using financial capital to secure loans, to invest more, and to earn more (thus increasing the return on the capital or investments) providing that your debt service is less than the increase in income. If everything aligns properly, using leverage in this manner can be quite successful; but franchising can be even better!
The real opportunity for using leverage in franchising relates not to your investment in the financial side of franchising, it relates to the investment you’re making of your time and talent. Finding a high quality franchise system that provides an opportunity to invest your personal assets of time and talents is the key to unlocking this definition of leverage. The franchisor develops a system or method of operation that employs the franchisee’s personal assets in a manner that drives the income from the business to levels that are not available from an investment of capital alone. These are the systems where a very successful operator can generate returns greater than of the total initial franchise investment within a short period of time. Doing so highlights just how effective leverage can be!
If the return isn’t going to exceed what you would anticipate for a passive investment, why would you invest in that franchise? You’d be better off maintaining your current situation and making passive investments elsewhere.
But let’s go back to the challenge of finding a franchise that meets your ROI expectations. Keep in mind that higher cost does not mean higher returns. What you will want to do is find the ones with great management leverage opportunities to maximize the return on your personal assets of time and talents. These are often franchises with total investments of less than $200,000 and in some cases less than $50,000.
A critical step in your investigation of a franchise is to determine the average earnings of a typical unit during the first three years of operation. You can sometimes find this information by reviewing the franchise company’s FDD and focusing on Item 7, which details the investment required, and Item 19, which discusses the earnings of locations within the franchise system. Item 19, however, is optional and not all franchisors list this information. If this information is available for those companies you are researching, you should be able to project the average three- to five-year returns on investment.
Often the most accurate information about unit performance comes from franchisees actually operating locations or territories so this is another source of financial information. Item 20 of the FDD provides a list of current and former franchisees along with their contact information. You will want to call a number of these franchisees and have a list of questions ready, including financial performance and operating costs. Your thorough research should leave you completely confident that you know both the high and low end of the range. Remember that your location or territory may only make a return in the average range so be sure it is a number that will make you happy.
With so many great franchise opportunities available, your due diligence and understanding of how to best leverage your personal assets of time and talents, along with your financial assets, will allow you to find a franchise that meets your ROI requirements in a relatively short period of time.