Chapter Two

Small Business

Chapter Objectives
After learning this chapter, students should;
 Define business, small business, industry , small scale industry and
business idea
 Explain the advantage of SB, problems of SB in Ethiopia contexts
 Explain the socio-political and economical aspects of SB
 Identify factors that impedes SB to fail

What is business?
A business can be defined as an organization that provides goods and services to others
who want or need them. When many people think of business careers, they often think of
jobs in large wealthy corporations. Many business-related careers, however, exist in small
businesses, non-profit organizations, government agencies, and educational settings.
Furthermore, you don't need a degree in business to obtain many of these positions.
A small business is a business that is privately owned and operated, with a small number
of employees and relatively low volume of sales. Small businesses are normally privately
owned corporations, partnerships, or sole proprietorships. The variables writers use in
defining small businesses include: size of working capital, number of employees, asset
size, annual sales, market share, and operational domain. For the sake of discussion, we
adopt the following definition. Small business is a business which employs less than 100
employees, is owned by one or few individuals, with the exception of the marketing
function has geographically localized operations, and does not dominate its industry.
Having the above definition in mind, businesses can be found in different industries but
they differ in their nature and importance from industry to industry which include:

a. Retail industry: Drug stores, clothing stores, auto accessories dealers, appliance
dealers, book stores, music stores…..etc.

b. Service industry: accounting firms, advertising agencies, managerial consultants,

barber and beauty shops, dry cleaners, travel agencies…etc.

c. Finance insurance and real estate industries: insurance agencies, real estate brokerage
firms, pawn brokers, small banks, loan companies…etc.

d. Transportation and other public utilities: Taxi cab companies, community news paper
publishers, local radio and television stations…etc

e. Manufacturing industries: Bakeries, sawmills, toy factories, job printing shops, shoe
factories, ice cream plants, furniture manufacturing plants…etc.

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Small businesses are common in many countries, depending on the economic system in
operation. Typical examples include: convenience stores, other small shops (such as a
bakery or delicatessen), hairdressers, tradesmen, lawyers, accountants, restaurants, guest
houses, photographers, small-scale manufacturing etc.

2.2. Why are small businesses Important to the economy?

The purpose is to understand the contribution made by small business as part of our total
economic system. Small firms operate in all industries, but they differ greatly in their
nature and importance from industry to industry. In thinking about their economic
contribution, therefore, we first need to identify the eight major industries (as classified
by the U.S. department of commerce) and note the types of small firms that function in
these industries. These eight major industries and examples of small firms in each are as
follows:

I. Wholesale Trade V. Finance, Insurance, and Real Estate

Wholesale drug companies Local insurance agencies

Petroleum bulk stations Real estate brokerage firms

II. Construction
VI. Mining
Generk2al building contractors
Electrical contractors Sand and gravel companies
Coal mines

III. Retail Trade VII. Transportation and public utilities

Hard ware stores Taxi-cab companies

Restaurants Local radio stations

IV. Services VIII. Manufacturing

Travel agencies Bakeries

Beauty shops Machine shops

As you can see in the above table, the vast majority of the 3.8 million businesses are
small. 98% have fewer than 100 employees.

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Although small businesses pose a number of challenges to the entrepreneur and have
certain limitations, a countries economy cannot superior over large ones in certain
aspects of business activities.
First, let’s try to see why it is advisable for an individual to start when embarking on
entrepreneurial ventures.
1. Providing job opportunities: this is one way in which small businesses contribute to
the country’s economy. In fact, in most countries, the number of new jobs created by
small business is significantly higher than created by large businesses. For example,
in the US, 50% the employment comes from small businesses and each year small
businesses account for about 80% of the new job created.

2. Introducing innovations: new products which originate in the research laboratories

of big businesses make a valuable contribution to our standard of living. There is a
question, however, as to the relative importance of big businesses in achieving the
truly significant innovations. Usually, the research departments of big businesses tend
to emphasize the improvement of existing products. Records show that many
scientific breakthroughs originate with independent inventors and small
organizations.

3. Stimulating economic competition: small business by definition is one that does

not dominate its industry, and competition will be closer to perfection when the
market price and supply when operating individually.

4. Aiding big businesses: the fact that some functions are more expertly performed by
small businesses enables small businesses to contribute to the success for larger ones.
Especially, there are two types of business activates that are performed by small
businesses inexpensive consumer products find it desirable to own resale and retail
out lets. Second, supply functions. Most small businesses act as suppliers and sub
contractors for large firms.

5. Producing goods and services: we depend highly on small businesses for the
provision of most goods and services we need in our lives. In fact, if it was not for
small businesses, we would have not been able to find the goods and services we need
at the time we need them, in a convenient place, and at the quantity we prefer.

In addition to the above general advantages small businesses offer a country’s economy,
they have certain benefits to the individual entrepreneur. These include:
 Small businesses require less time, energy and financial resources to establish

 They also provide the entrepreneur with greater autonomy, and independence-because
the money needed to start small businesses is relatively small, the entrepreneur can
raise most of it by him/herself without relinquishing significant onrushing interest and
control.

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 In addition to these, small businesses help the entrepreneur develop his skill in
running organizations as he is expected to perform different kinds of activities
concerning the business. These include; business planning, investment and finance,
customer relations, personnel and human resources, cash control and book keeping,
inventory control, purchasing, marketing and sales, and leadership.

2.3 Economic, social and political aspects of small business enterprise

Small businesses have a vital role to play in the Ethiopian economy. Small businesses
need a strong support from the government and the society on grounds of the following
socio-economic and political benefits they provide.

1. Equitable income distribution or improved standard of living

The objective of the incumbent Ethiopian government is to ensure an economic system

where there is decentralization of economic power and equitable distribution of wealth.
The benefits of economic growth should be shared by as many people as possible and
should also provide better quality of life by enhancing the general standard of living of
the people.

2. Less capital and more labor (The Employment Argument)

The main problem is that we have vast manpower but inadequate capital, which has
resulted in increasing unemployment. This is unlike in situation in western countries
where manpower is limited but capital resources are enormous. Planners have realized
the necessity of encouraging small industries because they require less capital but
generate more employment. It is estimated that through the net-out per worker n large
and medium industries is more than twice as compared to that in small scale industries,
the investment of capital per worker is about seven times.

The small-scale sector has the capacity to generate a much higher degree of employment
than the large-scale sector. For example according to the data collected by the in dial
development commissioner of small industries states that-the fixed investment in plant
and machinery per worker in the small-scale sector is about Rs. 3000 and Rs. 20,000 in
the large scale sector. The present inflationary trend is largely due to shortage of goods.

More production needs more capital in such a situation. These small industries will stand
in good position because they are less capital intensive and more employment oriented.

The argument is based on the assumption that small scale industries are labor intensive
and thus create more employment per unit of capital.

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 3. Removing regional imbalance (The decentralization argument)
Another problem is the continuous shifting of people from rural to urban areas which
causes over-crowding in cities with slum conditions due to lack of social and medical
amenities which require heavy investment. This problem can be solved inducing people
to set up small industries in rural areas.
The prolific setting up of agro-based industries will go a long way in creating a balance in
our country’s economy. In order that industrialization may benefit the economy of the
country as a whole, it is important that disparities in the matter of development between
different regions should be progressively reduced.
Large scale industries have the tendency to concentrate in big cities. As a result semi
urban and rural areas remain deprived of the benefits of industrialization. Moreover,
undue concentration of large industries in urban areas creates several problems. E.g.,
pollution, slums, shortage of civic facilities, etc. due to employment opportunities in the
countryside, people migrate in large number to big cities. Small scale units can be located
in rural and semi urban areas to reduce regional disparities.

4. Export promotion
Small-scale industries are now a day opening up fresh avenues in the export market in
our world. Realizing the importance of the small-scale sector in the economy the
Ethiopian government has adopted several measures to speed up the growth for small
industries.

2.4 Small Business Failure Factors

1. Choosing a business that isn't very profitable. Even though you generate lots of
activity, the profits never materialize to the extent necessary to sustain an on-going
company.
2. Inadequate cash reserves. If you don't have enough cash to carry out through the
first six months or so before the business starts making money, your prospects for success
are not good. Consider both business and personal living expenses when determining
how much cash you will need.

3. Failure to clearly define and understand your market, your customers, and your
customers' buying habits. Who are your customers? You should be able to clearly
identify them in one or two sentences. How are you going to reach them? Is your product
or service seasonal? What will you do in the off-season? How loyal are your potential
customers to their current supplier? Do customers keep coming back or do they just
purchase from you one time? Does it take a long time to close a sale or are your
customers more driven by impulse buying?

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4. Failure to price your product or service correctly. You must clearly define your
pricing strategy. You can be the cheapest or you can be the best, but if you try to do both,
you'll fail.

5. Failure to adequately anticipate cash flow. When you are just starting out, suppliers
require quick payment for inventory. If you sell your products on credit, the time between
making the sale and getting paid can be months. This two-way tug at your cash can pull
you down if you fail to plan for it.

6. Failure to anticipate or react to competition, technology, or other changes in the

marketplace. It is dangerous to assume that what you have done in the past will always
work. Challenge the factors that led to your success. Do you still do things the same way
despite new market demands and changing times? What is your competition doing
differently? What new technology is available? Be open to new ideas and experiment.
Those who fail to do this end up becoming pawns to those who do.

7. Overgeneralization. Trying to do everything for everyone is a sure road to ruin.

Spreading yourself too thin diminishes quality. The market pays excellent rewards for
excellent results, average rewards for average results, and below average rewards for
below average results.

8. Overdependence on a single customer. At first, it looks great. But then you realize
you are at their mercy. Whenever you have one customer so big that losing them would
mean closing up shop, watch out. Having a large base of small customers is much
preferred.

9. Uncontrolled growth. Slow and steady wins every time. Dependable, predictable growth
is vastly superior to spurts and jumps in volume. It's hard to believe that too much
business can destroy you, but the textbooks are full of case studies. Going after all the
business you can get drains your cash and actually reduces overall profitability. You may
incur significant up-front costs to finance large inventories to meet new customer
demand. Don't leverage yourself so far that if the economy stumbles, you'll be unable to
pay back your loans. When you go after it all, you usually become less selective about
customers and products, both of which drain profits from your company.

10. Believing you can do everything yourself. One of the biggest challenges for
entrepreneurs is to let go. Let go of the attitude that you must have hands-on control of all
aspects of your business. Let go of the belief that only you can make decisions.
Concentrate on the most important problems or issues facing your company. Let others
help you out. Give your people responsibility and authority.

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11. Putting up with inadequate management. A common problem faced by Successful
companies is growing beyond management resources or skills. As the company grows,
you may surpass certain individuals' ability to manage and plan. If a change becomes
necessary, don't lower your standards just to fill vacant positions or to accommodate
someone within your organization. Decide on the skills necessary for the position and
insist the individual has them.

Success in business is never automatic. It isn't strictly based on luck - although a little
never hurts. It depends primarily on the owner's foresight and organization. Even then, of
course, there are no guarantees.

Starting a small business is always risky, and the chance of success is slim. According to
the U.S. Small Business Administration, over 50% of small businesses fail in the first
year and 95% fail within the first five years.

2.5 Problems in Ethiopia Small Business

Small scale industries have not been able to contribute substantially as needed to the
economic development particularly because of financial, production, and marketing
problems. These problems still major handicaps to their development. Lack of adequate
finance and credit has always been a major problem of Ethiopian small business. Small-
scale units do not have easy access to the capital market because they mostly organized
on proprietary partnership basis and are of very small size. They do not have access to
industrial sources of finance partly because of their size and partly because of the fact
that their surpluses which can be utilized to repay loans are negligible. Small-scale
industries find it difficult to get raw materials of good quality and at cheaper rates in the
field of production.

2.6 Business idea

A business idea is a concept which can be used for commercial purposes. Business ideas
are all around you. Some business ideas come from a careful analysis of market trends
and consumer needs; others come from serendipity. If you are interested in starting a
business, but don't know what product or service you might sell, exploring these ways of
getting business ideas flowing will help you choose.

2.7 Sources of Business Idea

1) Examine your own skill set for business ideas. Do you have a talent or proven track
record that could become the basis of a profitable business? To find a viable business
idea, ask yourself, "What have I done? What can I do? Will people be willing to pay for
my products or services?"

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2) Keep up with current events and be ready to take advantage of business
opportunities.
If you read or watch the news regularly with the conscious intent of finding business
ideas, you'll be amazed at how many business opportunities your brain generates.
Keeping up with current events will help you identify market trends, new fads, industry
news - and sometimes just new ideas that have business possibilities.

For instance, same-sex marriages are now legal in Canada. There are now also
entrepreneurs who are selling tourist travel packages that include a marriage ceremony to
same-sex couples from other countries. Would you have identified that business
opportunity when you heard that the Canadian marriage laws had changed?

3) Invent a new product or service.

Think back 30 years ago. Was there a huge demand for anti-virus software, Internet
Service Providers, or desktop computers? No! The key to coming up with business ideas
for a new product or service is to identify a market need that's not being met. The clamor
for ever-increasing security, for instance, has led to an explosion of new security products
and services, ranging from iris-recognition machines through home security services.

Look around and ask yourself, "How this situation could be improved?" Ask people
about additional services that they'd like to see. Focus on a particular target market and
brainstorm business ideas for services that group would be interested in

4) Add value to an existing product.

The difference between raw wood and finished lumber is a good example of putting a
product through an additional process which increases its value, but additional processes
are not the only way value can be added. You might also add services, or combine the
product with other products. For instance, a local farm which sells produce also offers a
vegetable delivery service; for a fee, consumers can have a box of fresh vegetables
delivered to their door each week.

What business ideas can you develop along these lines? Focus on what products you
might buy and what you might do to them or with them to create a profitable business.

5) Investigate other markets.

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Some business ideas aren't suited to local consumption - but appeal greatly to a foreign
market. Finding out about other cultures and investigating other market opportunities is
an excellent way to find business ideas.

6) Improve an existing product or service.

There are very few products (or services) that can't be improved. Start generating
business ideas by looking at the products and services you use and brainstorming ideas as
to how they could be better.

7) Get on the bandwagon.

Sometimes markets surge for no apparent reason; masses of people suddenly "want"
something, and the resulting demand can't be immediately met. For example, during the
SARS epidemic, there was an insatiable demand for facial masks in several countries -
and many entrepreneurs capitalized on this business idea.

A "bandwagon effect" is also created by larger social trends. There is much more of a
demand for home-care services for the elderly than is currently being supplied. And the
trend for pets to be treated as family members continues, creating demand for all kinds of
pet-related services that didn't exist even ten years ago.

Look at existing businesses and the products and services they offer and determine if
there's a need for more of those products or services. If there is, develop business ideas to
fit the market gap.

2.7 Definition of Industry and Small Scale Industry

What is Industry?

An industry is an institution where raw material is purchased from suppliers, converted

into a finished product, using machinery, labor and sold to buyers. Conversion of raw
material means changing the size, shape, chemical properties, and assembling different
parts. An industry is able to carry out the functions of buying, manufacturing and selling
its product with the use of an organization, an organization being a collection of people
with of different skills, who coordinate the various functions involved. It is a basic
category of business activity. The term industry is sometimes used to describe a very
precise business activity (e.g. semiconductors) or a more generic business activity (e.g.
consumer durables). If a company participates in multiple business activities, it is usually
considered to be in the industry in which most of its revenues are derived.

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2.8 Small Scale Industry

Small scale industries have been defined as industrial units engaged in

manufacturing/preservation activities or repairing/servicing operations not exceeding
approximately Br. 1,000,000.

2.9 Characteristics of Small-scale Industries

1. Closely held: - the unit is generally a one-man show. Even if the unit is run by a
partnership concern/company, the activities are mainly carried out by one of the
partners/directors and the others are merely sleeping partners who generally assist
in providing finance.
2. Personal character: - there is close personal contact/supervision of all activities,
say purchase, production, labor, and sale of products.

3. Limited scale of operation: - has a lesser gestation (development) period. Small

scale unit has a limited share of a given market. The size of the firm in the industry
is small.

4. Indigenous resources: - Small scale industries can be easily located any where
subject to availability of raw materials, labor, finance, etc. small scale units use
local resources.

5. Labor intensive:-they are generally more labor oriented with comparatively

smaller capital investment than the larger units.

6. Local area of operation: - the operations of a small scale unit are generally
localized. However, market for its products need not be local. It may cater to local
and regional demands or its products may even be exported.

7. Simple organization: - A small business unit has few or no layers of

management. Division of labor or specialization is low and the resources are
limited.

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 Relationship between Small and Large Units

Small Scale Units Large Scale Units

 Personal character  Impersonal

 Local area of operation  Wide area

 Labor intensive  Capital intensive

 Small fixed investment  Large investment

 Decentralized location  Centralized location

 Independent management  Divorce between ownership

and management

 Proprietorship and partnership  Joint stock company

 Small uneconomic size  Large economic size

 Unorganized labor  Organized labor

 Limited scope for expansion  Greater scope for expansion

2.10 Forms of business organization

In the establishment and management of business, the most important thing is to select
the proper from out of various forms of business organization. Distribution of profit,

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concentration of capital, extent of risk, conduct of business control, etc., all depend on the
form of business organization. There are different forms of business organization.
The right of an individual or a group of individual to acquire legal title to property for the
purpose of controlling them and enjoy the profits and gains from such possession and
getting personal satisfaction by operating businesses represents ownership of business.

i. Sole proprietorship

Meaning and Definition

This is the simplest and oldest for of business organization. It is controlled and owned by
a simple person. Under this form of business unit, the individual owner is responsible to
introduce the entire capital, uses his/her own skill and intelligence in the management of
its affairs, and is entitled to receive all the profits alone, bears the risks that he business
faces.

Feature or Characteristics
A. Single ownership: the most important feature of sole trading is that it consists of one
person ownership.

B. Individual capital contribution

C. Individual management and control

D. Ownership and risk going side by side

E. No separate existence of business and its owner

F. Limited area of operation

G. Unlimited liability

H. Free from legal formalities in operation

I. Freedom of occupation

Advantages of Sole proprietorship

a. Easily formed: it is very easy to form a sole trading enterprise. What is required is
simply that the concerned individual should make up his/her mind to start a business.
No legal formalities or other complicated formalities are required to be followed. This
explains why we find a large number of business units of this form.

b. Incentive: the owner is entitled to the entire profits of the enterprise. He/she is free
from any outside intervention. This gives great inventive t her/him to take personal
….

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c. Freedom of action: the entrepreneur is the master of his/her business. He/she is free
from any outside intervention. He/she can take quick and prompt decisions and
implement them.

d. Business secrecy: the owner can keep his/her business secrets entirely to him/herself.

e. Social desirability: from social point of view sole trading enterprises are desirable as
they ensure that too much wealth does not concentrate in few hands, because the y are
by nature, small undertaking.

f. Personal Touch: a sole owner of enterprise is in a position of maintain personal

contacts with his/her customers who are limited in number. Individual attention to
customers results in creation satisfactory sales. It also enhances good will and
reputation of the business. Since the enterprise is small, the owner can create and
maintain close tough with his employees. This enables both the employer and the
employees to appreciate the difficulties and problems of each other. This results in to
industrial peace which is of vital importance of the prosperity of the business.

g. Superior output at low cost: on account of very close supervision over details,
quality of the goods is taken care of the cost per unit is low. Nobody can waste
materials or time or spoil machines. Here, the overhead charges are also low.

h. National importance: there are limits on the expansion of the business of sole
limited capital and limited managerial ability of the single entrepreneur. Thus, the
growth of business in the form of single proprietorship encourages decentralization
and leads to the distribution of income and wealth among many persons. To stimulate
entrepreneurs, the state taxes them as individuals and not as a business unit.

i. Ease of dissolution: the dissolution of this type of business is as easy as its

formation. The decision of the proprietor alone ends the business. He is not required
to justify her/his decision to with draw from the business in front of the authorities.
He/she s entitled to realize money from business debtors even after the dissolution of
the business.

Disadvantages of sole proprietorship

a. Limited resources: the entrepreneur, however rich he/she may be, has limited
resources. Further, this is also a limit to the amount of loan that one can raise. Thus,
the amount of income which derives from such business is relatively small.

b. Burdon of unlimited liability: a sole proprietor considers the debts of this business
as his personal debts. The fear of not losing his personal property in case of failure of
his business makes the sole entrepreneur excessively cautions. This acts as a brake on
business expansion.

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c. Limited managerial ability: one person, however brilliant he/she may be, is not
likely to be expert in all matters of business. Thus, the sole entrepreneur’s ability to
manage his/her business is limited.

d. Uncertain future: the sole proprietorship is not at all stable. The business may come
to a sudden end with the death, bankruptcy or lunacy/mental illness of the
entrepreneur.

ii. Partnership organizations

Meaning and definition

A pane ship is a form of organization in which two or more people jointly owned a
business and agree to share the profits or losses in an agreed proportion. Generally,
partnership grew out of the single proprietorship. The partners are joint owners of a
business. The partnership is based on the partnership agreement or deed. The number of
persons entering in to the agreement, their names, their mutual relations, the amount of
capital they are investing, their right and their duties, the share of profit between them,
etc, all these are clearly mentioned in the partnership agreement. There are two types of
partnership-ordinary and limited. In an ordinary partnership all the partners are
responsible for the debts of the firm. Here, the liability of the partners is unlimited. A
limited partner’s liability restricted (limited) to the amount of capital he/she has invested
in the business. But in such partnership there must be at least one general partner whose
liability for the debts of the firm not limited in one way. A general partner, however, is
the one who has full vice in management and who take complete responsibility for the
business. Limited partners cannot take share in management of the firm.

Characteristics of partnership
a. Plurality of persons: partnership is an association of persons. It s membership,
however, do not exceed more than 20.

b. Contractual relationship: this is one of the distinguishing features of partnership

from that of other relationships which arise by the operation of law and not from
agreement.

c. Sharing of profit: an agreement between two or more persons to carry on an activity

berth to partnership must be to earn and share profits. Agreement to share profits
implies to share losses also.

d. Existence of business: profits which are agreed to be shared by the partners must
come from a business and not from any other source. This means that there is not
business there is not partnership.

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e. Common management: the business of partnership must be carried on by all or by
any one or more of them acting for all. This means that the management of
partnership can be entrusted to any one or more than one partner. And even f any one
partner is managing the whole business, he/she is deemed to be acting for all. This
managing partner is acting as an agent of all other partners and binds them by his/her
actions.

f. Unlimited liability: each partner has an unlimited liability in respect of the firm’s
debts. It means that of the assets of the firm are not sufficient to satisfy the claims of
the creditors of the firm; the private assets of the partners can also be attached to meet
such claims.

g. Durations: the partnership business continues to exist until all partners are in a
harmony. Legally, partnership comes to an end if any of the partners retires or
becomes in solved or dies. However, of the remaining partners agree to continue the
business under the original form name, it may not be dissolved and will continue its
activity after settling the claim of the outgoing partner.

Advantages of partnership
A partnership has some obvious advantages over simple proprietorships. This business is
small, but not too small. It enjoys all the advantages of small business as well as some
advantages of large-scale business. Thus, partnership claims the following merits.
a. Ease of formation: like the sole proprietorship, a partnership form can be formed
without much expense and legal formalities. All that s required is an agreement
among the partners desiring to form a partnership business.

b. Larger resources: the resources of the partnership firm are usually larger than those
of sole proprietor.

c. Prompt decision: it is possible to take decisions quite promptly although not as

promptly as in the case of sole proprietorship. But the partners can take balanced
decisions as they possess different skills.

d. Flexibility: the nature of the business can be changed quickly if the need arises. Only
an agreement of the partners is necessary.

e. Lighter risk: the losses of the firm are divided and do not have to be borne by one
man alone.

Disadvantages of partnership
A partnership suffers from certain from certain drawbacks or demerits also. They are as
follows:

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a. Lack of harmony: misunderstandings generally arise and the business suffers.
Quarrels among the partners are quite common. No partner then pays any serious
attention to the business.

b. Unlimited liability: the partners other than any limited partner are individually
responsible for the debts of the business, even to the extent of their private
possessions.

c. Lack of stability: the partnership firm has to be dissolved in case of retirement,

death, insolvency or insanity of a partner. Thus, there is no continuity of life in a
partnership.

d. No legal entity: a partnership firm has no independent existence apart from the
persons who form it.

e. Limited resources: the resources at the command of the form will always be less
than that of a joint stock company because the partner members are few.

iii. Joint stock company/Corporation

Meaning, organization and finance

When business developed on large scale during the last part of the nineteenth century,
even the partnership form of business organization were not sufficient to provide
necessary amount of capital which factories, wholesale were houses, and large scale retail
stores required. As already pointed out, the main drawbacks of sole proprietorship and
partnership were limited resources, unlimited liability and drawbacks of continuity. Thus,
in order to overcome these drawbacks, the joint stock company is a business association
of people who contribute capital to conduct a business and agree to share the resulting
profits or losses. In Ethiopia, Joint stock companies are normally known as Share
companies.
A joint stock company is organized initially by interested entrepreneurs known as
promoters. These people conceive the scheme of business and they continue to pass
through different steps unit the company is formed. They draft the memorandum of
association, which contains the name of the company, its location and address, its aims
and objectives, the amount of the share capital, the value of shares, etc. on the other hand,
the starters of the business draft articles of Association which contains the internal rules
and regulations of the company. These rules and regulations include how shares are
issued and transferred, how election of the board of directors is conducted, and what are
the duties and responsibilities of the directors, etc.
The above discussed two important documents of a joint stock company are submitted to
the registrar of joint stock companies in the ministry of Industry and commerce for
government approval. If the registrar is satisfied that the requirement of the law have
been fulfilled, a certificated of incorporation is issued in the name of the joint stock

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company. The joint stock company then assures its legal body. Thus, a share company
can accuse and be accused against any unlawful action that may happen. The money
collected, the promoters are supposed to call a general meeting of all the shareholders
(share holders). This general meeting of the body of share holders will appoint the board
of directors that are responsible to follow the day-to-day affairs of the business enterprise.
As we have already seen the owners of sole proprietorship and partnership usually
manage their own enterprises. But in a share company every stock-holder is a part-owner,
and one joint stock company may have hundreds of shareholders. In addition, every share
holder is free to sell some or all his shares at any time. This means that the ownership of
the business enterprise may change frequently. In most cases, therefore, it would be
impractical for all owners of the joint stock company to participate directly in its
management. Instead, they meet once a year to vote on matters of general policy and
elect a board of directors to represent them. Each share holder is allowed have votes as he
owns shares. For example, if Ato Zeru has 100 shares, he may have only 1o times voting
rights. The board directors appoint officials, which is, manager, deputy manager, secrecy,
etc…to manage the business enterprise. The manager is then responsible to the board of
directors. The board of directors too are, are responsible for reporting annually. It is not
necessary for an officer of a joint stock company to be a shareholder. He can be any
salaried entrepreneur.

Chief characteristics of Share Company

a) A share company has a separate legal existence apart from its members. The member
and the company are both persons in the eyes if law so that a member of a company
can both owns its shares and be its creditor.

b) A share company has a perpetual existence once it is formed it continues for

unlimited period of time until it’s formal liquidity. The death or insanity of any share
holder does not affect its existence members may come and go but the company
would go forever.

c) Unlike a sole proprietorship or partnership the liability of the owner or members of a

joint stock company is limited. Of anything goes wrong with the company the share
holder can be asked only to the extent of the amount held by him in shares he/she
can’t be called to meet the debts of the company out of his personal property.

d) Even though shareholders are the owners of share companies, the task of the
management is left to the board of directors who are separate from the body of
shareholders. A partner is an agent of the partnership firm as well as all the other
partners. But a shareholder is not the agent of the company or other shareholders. It is
the directors who act as the agent of the company.

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e) A partner in a partnership firm cannot transfer his interest without the knowledge of
the partners. But the shares of a company are freely transferable except in a special
class of companies. The share holders who decide to transfer his/her shares either by
selling or by any other means is not forced to tell o make know the other members or
shareholders of the company.

f) A partnership can change the purpose of its business activity at any time with the
knowledge of the partners. No formality is needed. The purpose for which a company
is formed and are given in its memorandum of association, cannot be changed so
easily. This can be changed only with approval of the court.

Private and public limited company

A company can be either private limited or public limited depending upon it’s
characteristics. The distinguishing feature of private share company will have a limited
number of shareholders generally restricted to the members of the family. On the other
hand, a public limited company will have a large number of shareholders from different
classes of the society. These essential differences between the two relate to their size,
method of collecting capital and the transferability of shares. Public companies will be
large in size with huge amount of capital where shares will be sold in public and will be
easily transferable also. Unlike this, a private company will have limited capital with
fewer shareholders and the shares will be transferred only among themselves and not in
open market.

Merits of Joint Stock Company

a. Financial strength: the share company form of organization is well convenient for
raising large amount of capital. It can issue various type of shares to the public. In the
case of public company there is no limit on the number of shareholders. The shares
are of small value from a company and leave the responsibility of management to the
board of directors. The shareholders are not bothered about management of the
business enterprise. They can look after their own business profession or job. Also, as
the shares are made transferable by selling them, this works as an add attraction to the
investors. All these features help to enlarge the capital of a share company.

b. Limited liability: this is important feature which attract investors to buy shares from
company. A shareholder’s liability is limited to the value of the shares only. Their
personal property cannot be cleared upon for the purpose of liability of the share
company.

c. Benefits the Economic of large scale: it is possible to use modern machinery and
division of labor by employing specialist workers and large capital so that to benefit
higher profits by producing large amount of production at a cheaper price per unit of
output.

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d. Scope of Expansion: as there is no any limit to the shareholders in a public company,
there is a greater scope for expansion of business. A company which is making
greater profits can create big reserves which can be used for the expansion of the
business.

e. Transferability of shares: a shareholder can sell his/her shares whenever he/she

likes. They are not tied up for life to the fortunes of a company. When they need
money they can get by selling their shares. Thus this attracts and encourages
investors.

f. Social benefits: the share company form of organization has encouraged the habit of
saving and investment among the public.

Also, as companies employ or hire professionals, managers, it helped the

development of management as profession. Further, as the affairs of the company are
published and as the companies are regulated and controlled by the state, the public
has great confidence in this form of business organization.

Demerits of a share company

A. Formation in difficult: the formation of a share company asks a long process. There
are many rules and regulations that must be accomplished before it comes into
existence. Also a large amount of money is to be spent in order to fulfill certain
preliminaries.

B. Fraud and Exploitation: the shareholders can face a chance of exploitation by

dishonest directors. This frights away the investors from buying shares from a
company.

C. Centralization of control: the shareholders who are the proprietors of the company
have very narrow chance to participate in the affairs of the business. They are
generally spread throughout the country and even in some parts of the world, that is,
far away from the business of the share company. Hence, they cannot attend in the
company’s meetings. The result is that there is a concentration of control in few
hands, usually by the directors.

D. Lack of personal touch: the larger the organization, the more impersonal it tends to
become to both employees and customers that is the owners of the company have not
personal touch with the employees and the customers.

E. Delayed actions: there are certain things that should be done by the members in their
meetings. Their absence any retard the activities of the business. Further, the
directors may become irresponsible since their liability is limited.

Reading assignment

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 1. Steps in setting a small scale unit

2. Merits and demerits of private and public limited company

Activities
1. SBs are highly labor intensive and less capital intensive. Explain the
statement detail and compared to developed countries and developing
countries focuses on the expansion of SB, so why developing counties focus on
such businesses than developed countries. Explain by taking two countries.
2. Explain how SB can promote the economical, political and social
development of a particular country by taking one example.

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