How to Calculate and Compare Franchisee Returns
Before you invest in a franchise, you’re likely to think about what the return on your investment might be. Why should you invest in a franchise business rather than the stock market, for example? A franchise ROI is not quite as easy as a stock’s ROI to calculate, but it is certainly more exciting to contemplate – and another way to evaluate a franchise opportunity.
What is ROI?
Before we examine how to calculate the ROI of a franchise business, let’s remind ourselves what ROI is.
When considering a bond, the ROI is easy to calculate. Let’s say that you invested $100,000 in a bond three years ago. Your total return (the interest you received) is $12,000. The return on your investment is 12%. Calculated by year, your compound annual growth rate (CAGR) is 3.85%.
For a stock, the calculation is a little more complex. You must include the capital gain and the dividends you receive. Let’s say that you bought $100,000 of stock when the share price was $5. After three years, the share price has increased to $6.25. Your stock is now valued at $125,000. However, you have also received dividends totaling $7,500 during this time. Therefore, your total return is $32,500, or 32.5%. This equates to a CAGR of 9.83%. That’s toward the upper end of what might be considered an average ROI of around 7% to 11% on stocks.
When you calculate the ROI on real estate, the calculation is like the calculation of a stock’s ROI, except instead of dividends, your income is rent.
For ease of explanation, we haven’t included the costs associated with holding an investment (such as commission and management fees on stock and bonds, legal fees and property maintenance costs on real estate).
What is different about a franchise ROI?
There’s a big difference between investing in stocks and investing in a franchise. It is very rare that you will be a passive investor when you buy a franchise. You’ll need to commit time to your business. When calculating your ROI on a franchise, you’ll need to take this into account. You should certainly expect a higher ROI to compensate your time.
Let’s start with calculating the return on your invested capital. Just as you would with stocks or bonds.
Consider that after three years, your $100,000 investment has yielded a net profit of $50,000. You started slowly (the first year of a new business is always tough), but now the profits are rolling in nicely – and growing. Your initial investment has produced an ROI of 50% over three years, or 14.47% CAGR.
Good, but what about your time?
Let’s say that before you decided to invest in a franchise, you were working as an executive in the corporate world. Your salary was $75,000 a year. For the time you work in your new business, you pay yourself an equivalent income. Over three years, you receive a total of $225,000 in salary and $50,000 in net profits. A total return of $275,000, or 275% and a CAGR of 55.36%.
Of course, you might expect a better ROI on your franchise investment than you would on a bond. Franchise success cannot be guaranteed, and you are compensated by bigger potential returns.
Your time has been fully compensated, and you’ve made a good profit on top.
However, the ROI of a franchise doesn’t stop here.
Lifestyle – The hidden ROI of a franchisee
Now we come to an element of return on a franchise investment that is impossible to quantify: the entrepreneurial lifestyle. Only you can calculate what this is worth to you, but here’s a few examples of what you should consider:
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In your corporate life, half your day is wrapped up in mundane tasks that don’t challenge you, don’t excite you, and often make you lose the will to live.
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You currently have a boss that you dislike intensely. So much so that you hate going into work.
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Your work hours are rigid. That doesn’t leave you the freedom to enjoy time with your kids or doing the stuff you really love to do.
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You have a vacation home in the mountains, but you cannot take advantage of it.
If the franchise you buy gives you benefits that address these lifestyle issues, how do you value this? The lifestyle advantage that becoming a franchisee could offer may even outweigh the potential to make more money than you currently do in the corporate world.
Will your franchise investment pay a life-changing ROI?
When you are investigating franchise opportunities, you should always consider the potential returns. Get down and dirty with the franchisor’s business model and financial statements. Speak to existing franchisees and learn what they are making. Do your research and find out the typical ROI that franchisees are making on the franchises they have bought.
Do all this and measure it against other investment opportunities, other franchise opportunities, and doing nothing. And get help to do so.
Where do you start? Take the Franchisee Aptitude Test today.