Return of Investment on Your Franchise
When evaluating whether an established small business is franchise-able --- I’ve heard that the rule of thumb is that a potential franchisee should be able to see a 15% ROI on their investment. What about "out of pocket" earnings. In other words, what if the ROI is good……but the dollars are low. Example: if I sell a franchise to someone who can take out $50K per year in salary and profit….and that amount will grow 10 to 15 percent per year ----- is that a franchise that will look attractive to a lot of people?
This is fairly common question from prospective franchisors, but not with regard to the specific dollar amount or percentage ROI. There are three parts to my answer, although I could go on much longer and bore you completely.
First, I don’t know of a small business (indeed any business) that doesn’t maximize deductions as a means of lessening the tax burden. It is hard enough scratching out a living for most small time entrepreneurs once every government entity takes its bite, so the business owner is surely not going to pay one dime more than legally required. The result is that what 'might' very well be a $50K salary will be carved down to a smaller amount. Is this illegal or dishonest? Not one bit. Deductions are legal, so long as they’re legitimate. So the Part One answer is that the 'income value' of a small business is not discernable via 'salary'.
Second, in the world of franchising, on-going royalties (when paid as a percentage) are always paid as a percent of 'gross sales', nothing less. And, of course, the reason for this is all wrapped around Part One above. Royalties are calculated on gross receipts.
Third, franchises are purchased for myriad reasons, but 'provable income' is generally not one of them. Are you surprised? The fact is this: more than 75% of all franchise companies DO NOT offer 'earnings claims' that help buyers get a grip on potential earnings. Sure, a buyer can ask other franchisees how they are doing, but Part One is always part of the equation. Make sense?
Experienced, reputable franchise consultants learn to analyze the 'whole picture' when considering the franchising of a new concept. Yes, the financial model is a very important element, but there are others of equal and even greater importance. And to make sure this is all answered in a positive tone, certainly a business should be 'profitable' when thinking of turning it into a franchise, but 'profitability' is one of many considerations.
