Chapter 3

Business formation
 Contd…
• A business formation deals with the formalization and
actual implementation of business ideas into practice.
3.1. forms of business organization
the three basic legal forms are:
1. proprietorship- form of business with single owner
who has unlimited liability, controls all decisions
and receives all profits.
2. Partnership- two or more individuals having
unlimited liability who have pooled resources to
own a business.
 Contd…
3. Corporation – separate legal entity that is run by
stockholders having limited liability.
- These three basic legal forms are compared with
regard to ownership, liability, start-up costs,
continuity, transferability of interest, capital
requirements, management control, distribution of
profits and attractiveness for raising capital.
 Forms of business
factors proprietorship partners corporation
ownership individual 2- 5 persons Many
Liability of owners Individual liable All individual liable, Amount of capital
Limited partners contribution is limit
are liable for of shareholders
amount of capital liability.
contribution,
In LLP there is no
liability except
when negligence
exists.

Costs of starting None, other than Partnership Created only by

filling fees for trade agreement, legal statute.
name costs and minor Articles of in
filing fees for trade corporation, filing
name. fees, taxes and fees
for states in which
corporation register
to do business.
 Contd…
Continuity of Death dissolves Death or Greatest form of
business the business withdrawal of one continuity.
partner terminates Death or
partnership unless withdrawal of
partnership owner(s) will not
agreement affect legal
stipulates existence of
otherwise. business.
Death or
withdrawal of one
of limited partner
has no effect on
continuity
 Contd..
Transferability of Complete freedom General partner Most flexiable .
interest to sell or transfer can transfer his/her Stockholders can
any part of interest only with sell or buy stock at
business consent of all other will.
general partners. Some stock
Limited partner can transfers may be
sell interest restricted by
without consent of agreement.
general partners.
No transfer of
interest in an LLP.
Capital requirement Capital rose only by Loans or new New capital raised
loan or increased contributions by by sale of stock or
contribution by partners require a bonds or by dept in
proprietor. change in name of
partnership corporation.
agreement. In LLP,
entity raises money.
 3.2. definition and role of MSEs
3.2.1. definition of MSEs
Small business are playing an important role in the
industrial economy. These are particularly important
in the developing economies.
- There is a difference between small business owners
and entrepreneurial ventures as well.
- An entrepreneurial venture often is a growth oriented
innovative company with product/service offering
that are new to the market.
 Contd…
• Small businesses could be entrepreneurial ventures.
• Most entrepreneurial ventures start as a small
business.
• There are 2 approaches to define small business
1. Size criteria
- Size refers to the scale of operation.
A, financing of the business is supplied by one person
or a small group. Only in a rare case would the
business have more than 15 or 20 owners.
 Contd…
B, except for its marketing function, the firms operation
are geographically localized.
C, compared to the biggest firms in the industry, the
business is small.
D, the number of employees in the business is usually
fewer than 100.
2. economic/control criteria
Size does not always reflect the true nature of an
enterprise.
 Contd…
• All four of these characteristics must be satisfied if
the business is rank as a small.
1. Market share- the characteristics of a small firms
share of market is that it is not large enough to
enable it to influence the prices of national
quantities of goods sold to any significant extent.
2. Independence- means that the owner has control of
the business himself/herself. Have to refer to major
decisions.
 Contd…
3. Personalized management- is the most characteristics
factor of all. It implies that the owner actively
participates in all aspects of the management of the
business, and in all major decision making process.
- There is little delegation of authority and only one
person is involved when anything material is
involved.
4. technology- small business is generally labor
intensive and only few are technology intensive.
 Contd…
5. Geographical area of operation- the area of operation of a
small business is often local.
- Small business is a business that is privately owned and
operated, with a small number of employees and relatively
low volume of sales.
3.2.2. role of MSEs
1. Large employment opportunities
- MSEs are generally labor intensive. For every fixed amount
of investment, MSEs sector provides employment for
more person as against few person in large scale sector.
 Contd…
2. Economical use of capital
- MSEs need relatively small amount of capital. Hence
it is suitable to a country like Ethiopia where capital
is deficient.
3. Balanced regional development
-generally small business are located in village and
small towns. Therefore it is possible to have a
balanced regional growth of industries.
 Contd…
4. Equitable distribution of wealth and decentralization
of economic power
- It removes the drawbacks of capitalism, abnormal
profiteering, concentration of wealth and economic
power in the hands of few.
5. Unregulated growth of large – scale industries result
in concentration of economic power in the hand of a
few, and consequently, gross inequalities in the
distribution of income and wealth will occur.
 Contd…
6. Dispersal over wide areas- MSEs has a tendency
disperse over wider areas and they play a key role in
the industrialization of a developing country.
7. Higher standard of living – MSEs bring higher
national income, higher purchasing power of people
in rural and semi- urban areas.
8. Mobilization of locals resources- the spreading of
industries even in small towns and villages would
encourage the habit of thrift and investment among
the people of rural areas.
 Contd…
9. Innovative and productive
- New but simple techniques of production can be
adopted more easily by MSEs without much
investment.
10. Less dependence on foreign capital/export
promotion
- MSEs use relatively low proportion of imported
equipment and materials.
 Contd…
11. Promotion of self employment
- MSEs foster individual skill and initiative and
promote self- employment particularly among the
educated and professional class.
12. Protection of environment
- MSEs help to protect the environment by reducing
the problem of pollution.
13. Shorter gestation period- the time lag between the
execution of the investment project and the start of
flow of consumable goods is relatively short.
 Contd….
14. Facilitate development of large scale enterprises
- MSEs support the development of large enterprises
by meeting their requirements of inputs of raw
materials, intermediate goods, spare parts, and by
utilizing their output for further production.
15. Individual tastes, fashions and personalized service
- Small business have the flexibility to adapt quickly to
changes in the business or technological environment.
 3.3. classification of MSEs
1. In case of manufacturing enterprise
A, a micro enterprise- is one in which the investment in
plant and machinery(total asset) does not exceed birr
100,000 and operates with 5 people including the
owner.
B, small enterprise – is one in which the investment in
plant and machinery of birr 100,000 and not more
than birr 1.5 million and operates with 6- 30
persons.
 Contd..
2. In case of service enterprise
A, a micro enterprise – is one with the value of total
asset is not exceeding birr 50,000 and operates with 5
persons including the owner.
B, small enterprise – is one in which the total asset
value or a paid up capital of birr 100,000 and not
more than birr 1.5 million, and operates with 6-30
persons.
 Contd…
• Priority sector and sub- sectors for MSEs engagement
1. Manufacturing sectors- this is the one which
comprises textile and garment, leather and leather
products, food processing and beverage, metal works
and engineering , wood works including furniture
and ornaments service and agro- processing.
2. Construction sector – is the one which comprises
sub- contracting, building materials, traditional
mining works, cobble stone, infrastructure sub-
contract and prestigious goods.
 Contd…
3. trade sectors- is the one which comprises whole sale of
domestic products, retail sale of domestic products and
raw materials supply.
4. Service sector – is the one which comprises small and
rural transport service, café and restaurants, store service,
tourism, packing , management, project engineering ,
product design, beauty salon and so on.
5. Urban agriculture- is the one which comprises modern
livestock raring , bee production, poultry, fruits and
vegetables, modern irrigation and animal food
processing.
 3.3.1. levels of MSEs
• Start- up – refers to enterprises that incorporate people
who are interested to establish MSE and it is a level
where an enterprise begins production and service
under legal framework or legal entity.
• Growth levels – is a level when an enterprise become
competent in price, quality and supply and profitable
using the support provided.
• Maturity level- means when an enterprise able to be
profitable and invest further by fulfilling the definition
given to the sector and using the support provided.
 Contd…
• Growth- medium level – an enterprise is said to be
transformed from small to medium level of growth is
when it enabled to be competent in price, quality and
supply using the support given to the level.
3.4. setting up small scale business
3.4.1. steps for setting up entrepreneurial venture
- Once an individual decides to take up entrepreneurship as a
career path, to be a job provider instead of a job seeker,
s/he has to establish an enterprise. However, setting up of
a small business is a very challenging as well as a
rewarding task.
 Contd…
• The entrepreneurial process of launching a new venture
can be divided into 3
1. discovery- the first stage of discovery is to identify
opportunities that may form the basis of an
entrepreneurial venture.
Step 1 discovering your entrepreneurial potential – to know
more about your personal resources and attributes
through some self evaluation.
Step 2 identify a problem and potential solution – a new
venture has to solve a problem and meet a genuine need.
 Contd…
2. evaluation- you should have selected an idea worthy
of further detailed investigation.
Step 3 evaluating the idea as a business opportunity-
find out information about the market need. Is the
solution to this problem really wanted by enough
customers?
Step 4 investigate and gathering the resources- how will
the product get to market? How will it make money?
What resources are required?
 Contd…
3. exploitation/implementation- you should have
identified an opportunity that has reasonable
prospects of success, and analyzed what is required to
launch it.
Step 5 forming the enterprise to create value- set up a
business entity and protect any intellectual property.
Step 6 implementing the entrepreneurial strategy-
activate the marketing, operating& financial plans.
Step 7 planning the future- look ahead and visualize
where you want to go.
 3.5.small business failure and success
factors
• 3.5.1. small business failure factors
• Failure can be thrust upon an entrepreneur through
external conditions or fabricated by the entrepreneur
through personal short comings. Some of the major
causes of failure are
1. Inadequate management – business management is the
efficient and effective use of resources. For small
business owners, management skills are especially
desirable- and often especially difficult to obtain. Lack
of experience is one of their most pressing problems.
 Contd…
2. Inadequate financing- business failure due to inadequate
financing can be caused by improper managerial control as
well as shortage of capital. On the other hand, if you don’t
have adequate funds to begins with, you will not be able to
afford the facilities or personnel you need to start up the
business correctly.
- Other common causes of business failure are
A, neglect- occurs whenever an owner does not pay a due
attention to the enterprise. The owner who has someone
else managing the business while s/he goes fishing often
finds the business failing because of neglect.
 Contd…
B, fraud – involves intentional misrepresentation or
deception. If one of the people responsible for
keeping the business books begins purchasing
materials or goods for himself/herself using the
business money, the business might find itself
bankrupt before too long.
C, disaster – refers to some unforeseen happening. If a
hurricane hits the area and destroys the property in
the company's yard, the loss may require the firm to
declare bankruptcy. Same is true for fires, robberies
 3.5.2. small business success factors
• You will improve your chance of achieving success in
running a small business if you identify your
comparative advantage, remain flexible and innovative,
cultivate a close relationship with your customers, and
strive for quality.
• Small businesses are often better at distribution. Most
wholesale and retail trade are a small.
• The owner must have a purpose for being in business
and want to provide customers with value for their
money and having a variety of basic business skill is
important.
 Contd…
• The success factors are
1. Conducive environment
- Successful small enterprise do not emerge, and thereafter
survive and grow unless the environment is conducive.
Political, economical, technological and socio-cultural factors
in the environment impinge upon the life of the small
enterprises.
A, political climate – the overall political climate in a country is
important for small scale entrepreneur to consider. Small scale
entrepreneur will need positive and encouraging measures by
gov”t and political constituencies to establish private
investment.
 Contd…
B, economic environment – an analysis of the economic
environment is particularly helpful in investment
decision, market measurement and in forecasting.
C, technology – technological advances in the
environment create new needs for the small
entrepreneur as far as adaptation and adjustment is
concerned.
D, socio- cultural environment – it also creates a very
important climate for the survival of the enterprise.
 Contd…
2. Adequate credit assistance
- Small enterprise development cannot be ensured
without arrangement for financing. Adequate and
timely supply of credit is critical for new
entrepreneurs to emerge especially from a wide base.
3. Markets and marketing support
- Market for small enterprise in a developing country
can be quite a problem. The small business
entrepreneurs will be in competition not only with
locally mass- produced goods but even imports.