Researching Rates of Return
Q: I've been investigating a number of franchises, and they don't seem to be very consistent in terms of rate of return on investment. In fact, it sometimes appears that there is very little correlation between the total investment and the amount of money I can make in the business. Has there been a study on which franchises offer the best return on investment based upon a three- to five-year period after opening? If not, where can I get this information, and how do I know if it is accurate?
A: The short answer to his first question is no. Many years ago, statistics were quoted on the success rate in franchising as compared with independent businesses. You rarely see anyone quote these old statistics any longer, because, as it turns out, the studies were significantly flawed and likely invalid even then. A few years ago, the International Franchise Association sent out a recommendation that franchisors stop using those questionable statistics. If you are investigating a franchise opportunity, and the franchisor or broker is still quoting those old DOC or SBA studies about franchising to show you how safe your investment in a franchise will be, I would be a bit concerned.
There are no studies we know of that have examined the return on investment in franchising. Franchising is now used in more than 85 different industries, and returns vary widely between industries and even between the companies in those industry subsections. Indeed, given the wide variations in type of franchises being offered within some companies (in-line, mall-based, freestanding, express, mass gathering, kiosk, seasonal, single unit, multiunit, dual branding), not to mention differences in the maturity of the locations and demographic differences, such a study would be difficult if not impossible to complete.
To do your own examination, focus on two key disclosures items in a franchisor's Uniform Franchise Offering Circular (UFOC). The first is Item 7, which explains the investment in the franchise, and the second is Item 19, which discusses the earnings of locations within the franchise system. Unfortunately, the majority of franchisors still do not disclose earnings in their Item 19. Even if you have a franchisor's UFOC, you still may not be able to do a three- to five-year return on investment projections, because the franchisor may not include the necessary detail in their documents. For more detailed information on interpreting earnings claims, click hereand here.
The International Franchise Association's Education Foundation conducts the most comprehensive research on franchise industry issues today. Some of their studies are free online; some need to be purchased from the foundation. For more information, go to www.franchise.org.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.