Return on Investment
(ROI) Model
A practical guide to calculating return on investment, interpreting payback periods and understanding how different business opportunities are priced from an investor’s point of view.
What ROI Measures
ROI defines the annual return generated by an investment when compared to the total capital required to enter the transaction.
Total capital outlay must be complete
The investment amount should include the full capital required by the buyer. This may include the purchase price, assets, stock, franchise joining fees, transfer costs, and any other acquisition-related capital required to take control of the business.
Stock and assets are part of the investment
One cannot present an opportunity at a particular ROI and thereafter exclude stock or assets from the capital outlay. Stock and assets remain part of the investment until the business is ultimately sold again.
Working capital should be considered
Whether debtors, creditors and other working-capital movements should be included depends on the specific business and transaction structure. For a complete investment view, these items should at least be identified and explained.
Profit must be clearly defined
For this model, net profit is considered before owner’s remuneration and before the effect of depreciation, taxation, loan repayments and interest. If a full-time manager is required, the manager’s cost should be assessed separately.
Actual ROI Examples
The following examples show how the same purchase price can produce different payback periods depending on annual net income.
| Scenario | Annual Net Income | Total Purchase Price | ROI | Payback Period | Interpretation |
|---|---|---|---|---|---|
| Example 1 | R500,000 | R500,000 | 100% | 1 year | An ROI of 100% equates to a payback period of approximately one year, assuming no interest, no tax and no owner drawings. |
| Example 2 | R250,000 | R500,000 | 50% | 2 years | An ROI of 50% equates to a payback period of approximately two years before the effect of taxation, interest and owner drawings. |
The annualised profit figure forms the numerator in the ROI calculation.
This expresses the annual income as a percentage of the capital invested.
This shows how many years it takes to recover the original investment before adjustments.
Typical ROI Benchmarks
Different investment types carry different risk profiles and therefore attract different expected returns.
| Investment Type | Typical ROI | Explanation |
|---|---|---|
| Commercial or industrial property rented to tenants | 8%–10% | A commercial property investment should generally return around 9%–10% per annum within the first year, depending on the property, lease profile, tenant strength and location. |
| Commercial or industrial property plus a business as a going concern | 10%–16% | The investor should generally aim for a return above 10%, but the final expectation depends on the combination of property value, business income and operating risk. |
| Business as a running concern — seller aspiration level | 30% | A buyer may consider this level where the business has high barriers to entry, strong growth prospects, lower operating risk and is relatively easy to manage and control. |
| Business as a running concern — middle of the road | 40% | This represents a more balanced position between seller expectations and buyer requirements, depending on risk, stability and future prospects. |
| Business as a running concern — buyer aspiration level | 50% | A buyer is more likely to seek this level where the business is difficult to operate or control, has lower barriers to entry, weaker growth prospects or higher risk. |
How Buyers Interpret ROI
ROI is not only a calculation. It is also a risk measure and a negotiating tool.
Premium opportunities
A buyer may be prepared to pay a premium for a business in an exceptional location or in a highly desirable category. In this model, a premium is regarded as pricing closer to the seller’s aspiration level.
Lifestyle-driven acquisitions
Some assets, such as wine farms or lifestyle businesses in premium areas, may trade above normal ROI expectations because the purchaser is buying lifestyle value as much as investment return.
The ROI figures in this document are broad educational guidelines. Actual pricing may differ materially by area, business type, profitability, sustainability, risk, finance structure, taxation, buyer profile and market conditions.
Educational Summary
This model is intended to help buyers and sellers understand the logic behind ROI-based business pricing.
1. ROI must be transparent
The calculation should clearly disclose what income figure is being used and what costs are included in the capital outlay.
2. Payback period matters
Buyers translate ROI into time. A higher ROI usually means a shorter payback period and greater protection against risk.
3. Risk determines value
The stronger, simpler and more defensible the business, the lower the ROI a buyer may be willing to accept.