CHAPTER TWO

SMALL BUSINESS: VITAL COMPONENT OF THE ECONOMY

Objectives of the chapter

At the end of this chapter, students will be able to;

 Define small business.

 Describe the main characteristics of small scale industries.
 Understand the role of small businesses to the economy of a country.
 Indentify the problems of Ethiopian small businesses.
 Indentify the forms of business organizations and the legal issues of
entrepreneurs.

Chapter Description

This chapter deals about small businesses and to what extent these small businesses are
helpful for the poor and developing countries economy and economic, social and political
aspects. Furthermore the chapter discusses about small business failure factors, the main
problems in Ethiopian small businesses, forms of business organizations and the legal
issues that must be considered for entrepreneurs.

Contents

1.1. Definition of small business

1.2. Characteristic of small scale industries
1.3. Why are small businesses Important to the economy?
1.4. Economic, Social and Political Aspects of small business enterprise
1.5. K2Risks and causes of failure associated with small business
1.6. Problems in Ethiopia small business
1.7. Forms of business of organization
1.8. Legal issues for the entrepreneur

2.1Definition of small business

Defining small business is not as easy as it looks: we have different definitions depending
on the size of the industry we are talking about, the purpose of the definition, and the
country the definition is applicable to. 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:

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 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.
In terms of entrepreneurship, small business is a very personal approach to creating new
enterprises. And small businesses usually have limited growth opportunities and operate
in a community atmosphere.

2.2 Characteristic of small scale industries

1. Closely held: the unit is generally a one-man show. Even if a 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/directors who
generally assist in providing finance.
2. Personal character: there is close personal contract/supervision of all activities,
say purchase, production labor, and sale of products. The owner himself is
generally the manager. Therefore, these firms are generally managed in a
personalized manner. The owner has firsthand knowledge of whatever is going on
in the business. He actively participates in all aspects of business decision
making.
3. Limited scale operations: a small scale industrial unit has a lesser gestation
period. A 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 anywhere
subject to availability of raw materials, labor, finance, etc. small scale units use
local resources. Therefore, they have decentralized or dispersed location.
5. Labor intensive: they are generally more labor oriented with comparatively
smaller capital investment then the large units. The capital investment is limited
due to the use of simple technology. They require large amount of working capital
to meet their day-to-day expenses.
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.

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 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.

2.3 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.
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

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 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.
 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.

2.4 Economic, Social and Political Aspects of small business

enterprise
Small businesses (enterprises) have to play a vital role in Ethiopian economy. They need
a strong support on socio-economic and political grounds.
2.1.1. Socialistic Idea (The equality Argument)

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Our goal is being the establishment of a socialist pattern of society. Our objectives are
equitable distribution of wealth and decentralization of economic power. The benefits of
industrial growth should be shared by as many people as possible and should improve the
general standard of living. Proliferation of small enterprises will go a long way in
achieving these objectives.
According to this argument unregulated growth of large scale industries results in
concentration of economic power in a few hands and consequently grosses inequalities in
the distribution of income and wealth in the country. On the other hand, income
generated in large number of small enterprises is dispersed more widely and its benefit is
derived b a large population. This is due to wide spread ownership and decentralized
location of small scale units. In this way small scale enterprises bring about greater
equality of income distribution. It is also argued that most of the small scale units are
either proprietary or partnership concerns. As a result relations between workers and
employers are more harmonious in small enterprises than in large enterprises. Critics of
small business argue that due to absence of strong trade unions in small units, the
employer can more easily exploit workers. Wages and other benefits in the small firm are
lower than in large firms. By paying low wages, small business enterprises generate less
savings and less axes and there by result in low growth potential.
However, in underdeveloped countries workers prefer a low paid job to no job at all. In
the absence of small enterprises workers may have to lose even the small wage which
they hope to get. Moreover, wage rates in small firms can be improved through labor
laws and trade unions. Small enterprises also encourage competitive spirit and generate
the impulse of self development.
The state of Ethiopia where there is a large network of small scale enterprises, with
comparatively less investments in the large scale sector, the general standard of living is
much higher than in the states where heavy investments have been made in large scale
industries.
2.1.2. 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. It is said that employment
generation capacity of small sector is eight times that of the large scale sector. According
to prof. P.C. Mahalanobis, household or cottage industries require very little capital. With

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 any given investment employment possibilities would be ten or fifteen or even twenty
times greater in comparison with corresponding factory industries.
2.1.3. 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.
2.1.4. Creating self employment opportunities
In India, since independence it has had a steady rise in the number of qualified engineers
seeking suitable jobs. But having in adequate adventures, they can have self-employment
by setting up small industries with the help and expertise proved by the government and
other agencies. Main bank and have several industrial corporations, here, have arranged
special training programs for young entrepreneurs, who can easily set up their own units
with package assistance from the governments.
2.1.5. Ancillary Function
Many small-scale industries units supply and accessories bigger industries. This ancillary
function involves specialization in specific areas and results in greater profitability. The
government has, therefore, relaxed the ceiling of investment in plant and machinery for
ancillary unit.
2.1.6. 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.
2.1.7. Supply of critical raw materials
The government has also liberalized the importer to ensure regular supply of raw
materials to small industrial units, and devised a more efficient and consistent system of
distribution of critical raw materials.

2.5 Risks and causes of failure associated with small business

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.

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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?

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.

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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.

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.

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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.

In Small Business Management, Michael Ames gives the following reasons for small
business failure:

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 2.6 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 are 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. Because of their size and partly because of the fat limited profit, they search for
funds for investment purposes. Consequently, the approach moneylenders who charge high rate
of interest hence small enterprises continue to be financially weak.

Small-scale enterprises find it difficult to get raw materials of good quality and at cheaper rates
in the field of production. Very often they do not get raw materials in time. As a result, these
enterprises very often fail to produce goods in requisite quantities and of good quality of a low
cost. Furthermore, the techniques of production, which these enterprises have adopted, are
usually outdated. Because of their poor financial position they are not able to buy new equipment
consequently their productivity suffers. Besides, many small business enterprises are suffering
with the problem of marketing their products.

It is only by overcoming all these constraints that small enterprises can hope to make their
enterprises successful.

Management practice in Ethiopian Small Business

Small-scale industries sector occupies a strategic position of unique importance in the Ethiopian
economy. Today, the village and small-scale industries sector roughly account for roughly about
one-half of the total industrial production. Industrial relations is not a major problem in
Ethiopian small business and job specialization is not strictly adhered to by them, life time
employment may not be possible in Ethiopian small business because of limited scope they offer
for career growth of employees.

What is more important in the Ethiopian business environment is to change the attitude of work
force, make them disciplined and duty conscious, and inculcate in them a sense of commitment
towards their organization.

The small business survival rate

As a final note in this section, we must acknowledge the surprising rate of survival by small
firms. Debunking many myths about the failure rates if small firms, recent studies are
demonstrating a much higher level of survival for these enterprises than ever envisioned. The
most recent statistics show an overall 75.5 percent survival rate over a four-year period. Firms
without employees survived at a 72.4 percent rate, and firms with employees experienced at a
90.5 percent survival rate. These are encouraging figures as we begin the new century.

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Certainly numerous factors affect this survival rate. One factor enhancing survival may be the
technological development experienced over the last few years.

Table 1. Survival rates of small businesses

Firms closing each year Firms Surviving

All firms 1992 1993 1994 1995 Until 1996
without 7.3 6.7 5.8 4.7 75.5
employees
8.3 7.7 6.5 5.1 72.4
Firms with 2.7 1.5 2.3 3.0 90.5
employees

Source: Haile Gebretinsae Beyene, 2007. Page102

2.7 Forms of business of 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, 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.

2.1.8. 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
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 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 ….
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.
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 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.
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.
2.1.9. 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.
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.

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 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:
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.
2.1.10. Joint stock company/Corporation

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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 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 it’s existence members may come and go but the company would go forever.

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 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.
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 it’s 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
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 higher profits by producing large amount of production at a cheaper price per unit of
output.
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.

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 2.8 Legal issues for the entrepreneur
In establishing a new venture, the entrepreneur should deal with various legal issues.
Understanding the legal issues involved in entrepreneurship and taking appropriate measures
protect the entrepreneur from later legal complications which might hinder the smooth running
of the new business. In this regard, the entrepreneur must seek the assistance of a competent
attorney who is a better position to understand all possible circumstances and outcomes related
to any legal action.
Some of the legal issues the entrepreneur should address in string a new business are discussed
below.
Intellectual property: it refers to excusive right given to the entrepreneur to benefit from
his/her innovations and creations; and this includes: patents, trademarks, copy rights, and trade
secret. These are very important assets to the entrepreneur and must be understood even before
engaging the services attorney. Too often entrepreneurs, because of the lack of understanding of
instinctual property, ignore the important steps to take in order to protect these assets.
 Patents: a patent is a contract between the government and in inventor. In this contract,
the inventor agrees to disclose his/her invention in return for grants by the government
exclusively regarding the invention and becomes part of the public domain.
The regulations concerning patent were issued by the transitional government of Ethiopia under
the proclamation No. 123 in 1995 GC. The Ethiopian government grants patents for machines,
compositions of matters such as chemical compounds to by use in an industry, manufactured
items and for certain types of industrial designs. Previously the Ethiopian science and
technology institute was the central government office responsible for the determination of the
validity of patents. However, such matter concerning patent right are transferred to the Ethiopian
intellectual property office (EIPO).
Importance of patents; having laws and regulations concerning patent and other intellectual
properties benefits both the country and the individual entrepreneur in a number of ways:
 It is necessary to create favorable conditions in order to encourage local inventive and
related activities there by building up national technological capabilities.
 It has been found essential to encourage the transfer and adaptation of foreign
technology; by creating a good environment to assist the national development efforts of
the country.
 The task of fulfilling the nation’s multidimensional demand for harmonious scientific
and technological progress, to be used for the public benefits, shall be most effectively
served when there exists an appropriate legal frame work.
Application to get a patent: to obtain a patent in Ethiopian an individual must write an
application to EIPO. The application should have three parts.
 Introduction: it should contain the back ground and advantages of the invention and the
nature of problems that it overcomes. It also should clearly state how the invention differs
from existing offerings.
 Description of the invention: the application should also should brief description of the
drawings that accompany it. Then, this should be followed by a detailed description of
the invention, which may include engineering specifications, materials, components, and
so on, that are vital to the actual making of the invention.
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  Claims: claims serve as the criteria by which any infringements will be determined. They
serve to specify what the entrepreneur is trying to terms so as to prevent others from
getting around the patent. At the same time, the claims must not be so general that hide
the invention’s uniqueness and advantages.
 Patentable invention: to qualify of a patent, an invention must fulfill the following.
 An invention is patentable if it is new, involves an inventive step, and is
industrially applicable.
 An invention shall be considered new if it is anticipated by prior art. Prior art shall
consist of everything disclosed to the public, anywhere in the world by
publication in tangible form or by oral disclosure, by use or any other way, prior
to the application or, where appropriate. The priority date of the application
claiming the invention.
 Notwithstanding the above provision, the disclosure to the public of the invention
shall not be taken in to consideration if it occurred within the 12 months of
preceding the filing date or where applicable, the priority date of the application,
and if it was by reason or in consequence of acts committed by the applicant or
his predecessor in title partly with regard the applicant or his predecessor in title.
 An invention shall be deemed as involving an inventive step if, having regard to
the prior art relevant to the application and defined in the second criterion above,
it would not have been obvious to a person having ordinary skill in the art.
 An invention shall be considered industrially applicable when it can be made or
used in handicraft, agriculture, fishery, social services or any other sector.
 Non patentable invention: as per the patent regulations of Ethiopia the following
inventions shall not be granted patent protections:
 Inventions contrary to public order or morality
 Plant or animal varieties or essentially biological processes for the production of
plant and animals.
 Schemes, rules, or methods for playing games or performing a commercial
activity
 Discoveries of scientific theory and mathematical methods
 Methods for the treatment of the human or animal body by surgery or therapy, as
well as diagnostic method practice on human or animal body.
Disputes: occasionally, several people apply for a patent for the same invention. Under the
Ethiopian law, the person who first invented the item receives the patent. If it is unclear who
invented the item first, the EIPO decides who gets the patent in a proceeding called interference.
The losing party can appeal the decision on the court of appeals most other countries grant the
patent to who even first applied for the patent protection.

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Terms: if the EIPO finds that the invention fulfills the conditions listed above, grants the patent.
Under the current Ethiopian law, a patent is given for five years to the individual or individuals
who came up with the invention. However, if the inventor is an employee and does not work as
of his/her job, the grant will be given to the employer too.
Infringement: it refers to the act of making, using, or selling a patented invention without the
consent of the patent holder. Anyone who infringes a patented invention s susceptible to a legal
action by the patentee-the holder of the patent. The infringer might argue that the patent should
not have been given in the first place and it will be up to the court to decide whether or not the
patent is valid. Another defense that can be used by the infringer is the first sell principle. Under
is principle, once the patentee sells a particular item, the purchaser of that item may use it or
resell it without being considered an infringer.
Options to avoid infringement: to avoid risks that are associated with patent infringement, the
entrepreneur should follow the following procedures:
 Assess whether the item is patented or not
 If not patented, file for patent
 If a patent exists, determine whether the patent is new r nearly expired.
 If it is nearly expired, plan for introduction when the patent expires
 If it is new, determine if other expired patents exist the accomplish the same purpose
 If yes, develop the product using other designs
 If no, see if it is possible to introduce some changes in the product and commercialize it
without infringement
 If this is not possible, seek a license from the patentee
 If it is possible, produce using the modified version.
Trade Marks: it may be a word, symbol, design, or some combination of such, or it could be a
slogan or even a particular sound that identifies the source of the sponsorship of certain goods or
services. Unlike the patent, trade mark can last indefinitely, as long as it continues to perform its
indicated function. Most countries of the world legally protect trademarks. The current Ethiopian
law also gives companies the right to register their trademarks and have them protected. Trade
mark registration is carried out by the ministry of Inland revenue; and to be eligible for
registration that mark must be used in internal or foreign commerce. Sometimes the public may
stop thinking of the trade mark as a brand name and begins to think if it merely as a general
category of goods. The trade mark owner fails to do so, he/she will lose his/her legal rights to the
trade mark because the use of someone else’s trade mark in a way that confuses the public about
the source of the product. And, anyone who does this is considered an infringer and can be sued
by the trade mark owner.
Copy right: it refers to the right given to prevent others from printing, copying, or publishing
any original work of authorship. The protection in copy right does not protect the idea itself, and
thus it allows some else to used the idea or concept in a different manner.
Trade secrets: in certain instances, the entrepreneur may prefer to maintain an idea or process as
confidential and sell or license it as a trade secret. The trade secret will have a life as long as the
idea or process remains a secret. The trade secret will have a life as long as the idea or process
remains a secret. Employee involved in working with an idea or process may be asked o first
sign a confidential information agreement that will protect against their giving out the trade
secret either while an employee or after leaving the organization. The entrepreneur should hire
an attorney to help draw up any such agreement. The holder of the trade secret has the right to

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sue any signee who breaches such as agreement. What or how much information to give the
employees is difficult to judge and is often determined by eh entrepreneur’s judgment.

Review Questions

1. In view of the numerous definitions of small business, how can you decide which
definitions is correct?
2. Of the business with which you are acquainted, which is the largest that you consider to
be in the small-business category? Does it conform to the size standards use in the book?
3. On the basis of your acquaintance with small-business firms, give an example of a
specific small firm I the field of transportation, manufacturing and other public utilities.
4. Define the types of industry on the basis of size, what it makes, market, type, nature of
the process of manufacture, and on the basis of the important need of an industry.
5. Of the businesses with which you are acquainted, which of them can be categorized
under ancillary industries, tiny sector unit, and rural artisan?
6. Give example to each of the types of small scale industries.
7. By giving examples discuss the characteristics of small scale industries.
8. Suppose you decide to publish a tax advisory newsletter for small-business owners. How
would you define your target market in terms of business size? What difference would
this decision make?
9. What generalizations can you make about the relative importance of large and small
business in Ethiopia?
10. In which sectors of the economy is small business most important? What accounts for its
strength in these areas?
11. As noted in this chapter, small business is stronger in some industries than in others.
Would it be logical, therefore, for prospective entrepreneurs to concentrate their search
for opportunities more in the strong small-business industries-for example, in
wholesaling more than manufacturing?
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12. What special contribution is made by small business in providing jobs?
13. How can you explain the unique contributions of small business to product innovation?
14. What changes would be necessary for Ford Motor Company to continue operation, if, for
some strange reason, all firms with fewer than 500 employees were outlawed? Would the
new arrangement be more of less efficient than the present one? Why?
15. In what way does small business serve as a bulk ward of the capitalistic system?
16. List and describe some of the non-financial costs of business failure.
17. Explain and describe some of the quality of management as a cause of failure.
18. What is the difference between saying that “most firms fail within five years”? Which is
more nearly correct? Based on the statistics on business failure, would you describe the
prospects for new business starts as “bright” or “bleak”? Which is more nearly correct?
Based on the statistics failure, would you describe the prospects for new business starts as
“bright” or “break”?
19. How can “economic factors,” when cited as a cause of business failure, serve as a mask
for other contributing causes?
20. What are the major problems of small business in Ethiopia?

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