Tips to Estimate a Realistic Franchise ROI
The ROI of franchise businesses is easy to calculate, right? Isn’t it the same as any other ROI calculation? It’s the net return divided by the investment made, and then converted to a percentage, right? Not quite, no. If this is how you plan to calculate your ROI in franchise businesses, you’re making a common mistake that can be crippling – and you don’t want to risk being an unhappy franchisee.
What is an ROI franchise calculation?
The average return on investment franchise businesses is not calculated the same way as the return on a traditional franchise:
If you invest $100k into bonds, and this investment pays you interest of $12k over three years, the ROI on your investment is 12%, and the compound annual growth rate (CAGR) is 3.8%.
On an investment into shares, you must also consider the capital gain that you make as well as the dividends you receive. If you make $25k on the stock price and $6.5k in dividends over three years, your total return is $32.5k, or 32.5% (equivalent to around 9.8% CAGR).
The ROI of franchise businesses is calculated differently because it’s not a passive investment.
Take time to calculate the ROI of franchise businesses
Why does anyone invest? The underlying reason is lifestyle. Either current or future. And lifestyle is all about time. If you had enough money to invest and achieve an ROI that would replace the income from work – well, how much time would that buy you?
They say that you cannot put a price on time. But believe us when we say, when you are considering the potential ROI achievable when you purchase a franchise business, it’s crucial to consider time. The time you will spend on running your business.
Here’s what we mean:
Let’s say you are currently earning $75k a year as an employee. You want to pay yourself the same salary from your new franchise business. That’s reasonable. If your initial investment is, say, $100k, over three years, you would receive $225. Now, let’s say you also made $50k profits. That’s now a total of $275 ROI – or a CAGR of 55.36%.
Invest to get a dual ROI
When you invest in a franchise business, it’s crucial that you take your time into account. The capital that you invest is static. It’s a passive investment, like investing in bonds, shares, or even real estate. But, as a business, you’ll also be investing your time. You need to be compensated for this.
It’s crucial that you get a good return from both investments – your money and your time.
Would you go to work and expect your boss to say, “Thanks for your time this week, and for giving it freely?” No, of course, you wouldn’t. So, the franchise business you purchase must compensate you for the time and effort you put into it, as well as the capital you invest.
4 Tips to accurately calculate your franchise ROI
So, how do you calculate the real ROI on a franchise opportunity? Here are the three steps to take:
Step #1: Put a price on your time, talent, and skills
Is running your business something that few could do?
What parts of your business will you be most involved with, and what will you employ others to do?
What skills do you have, that you have earned either through experience or qualifications?
How much do you desire to be compensated for your time?
The answers to these questions will help you value your time, effort, and commitment to your business.
Step #2: Consider the opportunity cost of capital
What’s the opportunity cost of capital? Consider how much your capital might make if you invested it in another (passive) investment opportunity. For example, if you could achieve an ROI of 3% by keeping your cash in a savings scheme, then you need to be fully compensated for this – and then some.
Step #3: Speak to existing franchisees
We cannot stress highly enough how important it is to sit down with existing franchisees. Find out how much time they have put into their franchise businesses, and the effort they have expended. This will not only give you a more accurate idea of the time and effort you must put in to experience similar success, but also give you clues as to how your business may affect your personal life.
Step #4: Evaluate if the ROI of the franchise is worthwhile to you
With all this information to hand, now you can figure out if the franchise opportunity makes sense for you.
If you’re making less than you would by working as an employee, then it’s probably the wrong opportunity. But if you can make more for fewer hours, then this could be a great opportunity for you.
What’s the average return on investment in franchise businesses?
A question we get asked often is how much a new franchisee should expect to make on their franchise business.
When you receive the Franchise Disclosure Document (FDD), you’ll get some guidance on this – but you should always do your due diligence. This includes assessing the finest details of the franchise opportunity, the state of the market, and the prospects for the industry sector. And you should also speak to existing franchisees and an external business consultant.
Where do you start?
Either take a franchisee assessment or, if you prefer, book a free consultation to discuss your business goals and franchising objectives.