I have been researching what makes a healthy and thriving franchise system – and as a potential franchisee, this is something you must understand before buying a franchise.

The research has uncovered three pillars which make a healthy/thriving franchise – relating to fabulous leadership, great systems and people and a determined eye on the future.

But across everything, the one critical success factor underpinning the healthy/thriving franchise is franchisee profitability. In extensive research, franchisee profitability was talked about repeatedly as the number one factor that will influence the future of franchising.

Educating yourself is a great place to start and reading as broadly as you can to really get a feel for what franchising is all about is invaluable.

You may be wondering, how do I determine what makes a great franchise and one that makes it worthwhile to invest my hard-earned cash?

The first place to start for you, as an investor into a new franchise, is what will be the return on my investment and will I earn enough to support myself and my family.

Remember there are many options you have to invest your money: the bank, property, shares, superannuation.  There are also a multitude of ways to be self-employed in the new economy: Airbnb your house, drive an Uber, or juice Lime Scooters. 

So buying a franchise needs to stack-up when looking at all of your options.  Given the risk of investing potentially hundreds of thousands of dollars, will the returns be worth it?  This is the question that should be your top priority when assessing your new business.

If you can get a 10% return in the share market, or 5% in the bank, keep these figures in mind as you assess your potential new business.

However, determining your potential returns is not an easy task, even for experienced business people.

What does a profitable franchise look like?

From the research, the general consensus is a profitable franchise provides enough profit to pay the working owner a wage (based on the wage of a manager of the store/service) PLUS at least 20% of their investment amount per annum in profit on top of the working owner’s wage (assuming a five-year agreement). Note that 20% is the minimum with 30% being a more comfortable figure.

This is also handy to have as a formula:

Profitable franchise formula:  MR = WOW  + ROI > 20%

[Minimum Return = Working Owners Wage + Return on Investment of at least 20% (assuming a five-year franchise agreement].

As an example, assume a franchise has an entrance cost of $500,000.  The return expected to the franchisee is a minimum of approximately $70,000 (wages) plus $100,000 (EBITDA) which is $170,000.  Note that EBITDA is an accounting term which means earnings before interest, tax, depreciation and amortisation. In other words, it’s another term for your bottom-line profit.

So how do you uncover the profitability of a franchise?

You start by looking at the disclosure document which will have some financial information for you to go on.  This information can be quite broad and general so don’t stop there. My suggestion is that you seek out this information from current franchisees.  

Just this week, I had a detailed discussion with a franchisee from a major brand and he knew his return on investment and the margins of all of his products.  He could also tell me about the level of support from the franchisor and if he’d recommend the franchise to others. This kind of information is invaluable for any new franchisee.  Don’t be shy in seeking out this information – you and your family’s future livelihood is dependant on you making a decision based on the facts.

• If you want to know more about doing your homework before buying a franchise, check out the free Franchisee Pre-entry program, which is supported by the ACCC.