Franchise Research: Estimating Your Return on Investment (ROI)

return on investment ROI

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. While investigating franchise opportunities, be sure to look carefully at the company’s potential return on investment (ROI). And because a franchise purchase involves investing both your time and money, you should expect a higher ROI than you would from a passive investment of money only. Your franchise ROI will depend on many factors, including the structure of the franchise (retail vs. service), the length of time your franchise has been operational, the degree to which you understand and embrace the system, and your enthusiasm for the business.

Rule of thumb?

When you participate in a passive investment, you may be satisfied with a 10% to 15% annual ROI. 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 generalization that the more money you invest, the more money you’ll get back.

Similarly, people often assume that the more you invest in a franchise opportunity, the higher your return. However, there is often little correlation. Returns in franchising vary greatly, depending on the concept, industry, market, and individual operator. In many cases, the franchises that offer the greatest ROI are those that require a total investment of less than $200,000, sometimes even less than $50,000.

Gathering information

While investigating a franchise, you’ll want to determine the average earnings of a typical unit during its first three years of operation. Sometimes you can find this information in the franchise company’s Franchise Disclosure Document (FDD). Item 7 details the investment required and Item 19 specifies the earnings of units within the franchise system. However, not all franchisors include Item 19 in their FDD, as it is optional. If this information is available for the companies you’re researching, you should be able to project the average three- to five-year returns on investment.

You may be able to gather the most useful information about unit performance directly from current franchisees. Item 20 of the FDD provides contact information for current and former franchisees. Initiate phone calls with a number of franchisees and ask them about financial performance and operating costs. Thorough research should enable you to determine the high and low end of the range. Keep in mind that the location or territory you are considering may only perform in the average range. Make sure that the average is a figure that will make you happy.

 

Selecting a good franchisor and developing a solid financial projection are key in starting on your path to successful business ownership. Make sure you start with your eyes open and realistic expectations.