Chapter 4
Business Formation
Negash L.
Business formation
Business formation deals with the formalization and actual
implementation of business ideas into practice.
The most common Forms of Business Organization are:
♣ Sole Proprietorship : It is a business that is owned exclusively by
one person.
♣ Partnership: it is a business owned by two or more people.
♣ Corporation: it is a business with the legal rights of a person and
which may be owned by many people.
♣ Cooperatives:-It is an organization owned by members who pay
an annual membership fee and share in any profits.
Sole Proprietorship
♠ Is a form of business organization in which an individual:
♠ It introduces his capital
♠ It uses of his own skill and intelligence in the management of its
affairs
♠ It responsible for the results of its operation
♠ Receives the profits.
♠ Incurs any losses.
♠ Is liable for the debts of the business.
Advantages of the Sole Proprietorship
Simple to create.
Least costly form to begin.
Profit incentive.
Total decision-making authority.
No special legal restrictions.
Easy to discontinue.
Disadvantages of the Sole Proprietorship
Unlimited personal liability.
Full responsibility for all debts .
limited managerial experience
Limited skills and capabilities.
Feelings of isolation.
Limited access to capital.
Lack of continuity.
The death of owner dissolves the business.
Examples of Sole Proprietorship
Mobile phone repair shops,
Photo studio, Bookshop,
Bakeries, small town restaurants,
Retail stores,
Radio and watch repair shops,
Partnership
Is an association of two or more people who co-own a business.
Always wise to create a partnership agreement.
Best partnerships are built on trust and respect.
Types of Partnership
General partners
Take an active role in managing a business.
Have unlimited liability for the partnership’s debts.
Every partnership must have at least one general partner.
Limited partners
Can't participate in the day-to-day management of a company.
Have limited liability for the partnership’s debts.
Secret partner
Takes an active role in managing a partnership but his/her identity is
unknown to the public.
Silent partner
His/her identity and involvement is known to the general public, but is
inactive in managing the business.
Dormant or sleeping partner
Is neither known to the general public nor active in management.
Advantages of Partnership
Easy to establish.
Complementary skills of partners.
Increase of profit between partners.
Larger pool of capital.
Ability to attract limited partners.
Definite legal status.
Motivation of important employees.
Tax advantage over a corporation.
Flexibility.
Disadvantages of the Partnership
Unlimited liability of at least one partner.
Difficulty in disposing of partnership interest.
Lack of continuity.
Lack of harmony between partners.
Potential for personality and authority conflicts.
Partners bound by law.
Corporation
Is also known as Joint Stock Company.
Is an artificial person authorized and recognized by law,
with distinctive name and a common seal.
It comprises of transferable shares and having a
perpetual succession of life.
Characteristics of Corporation
Separate legal entity.
Limited liability.
Transferability of shares.
Perpetual existence.
Common seal.
Separation of ownership from management.
Supervision.
It has a written constitution.
Advantages of the Corporation
Limited liability of stockholders.
Ability to attract capital.
Ability to continue indefinitely.
Transferable ownership.
Legal entity status.
Managerial efficiency.
Financial strength.
Scope of expansion is high.
Disadvantages of a Corporation
Lack of owner’s personal interest.
Difficulty of formation/Cost and time.
Delay in decision making.
Lack of secrecy.
Potential loss of control by founder(s).
Double taxation.
Cooperatives
It is an organization owned by members/customers who pay an annual
membership fee and share profits
It has to adopt the following principles:
Members have an equal vote in decisions
Membership is open to every one who fulfills specified
conditions (e.g. Number of hour worked)
Assets controlled and usually owned jointly by members
Profit shared equally between members with limited interest
payment on loans made by members;
Members benefit from participation, not investment
Advantages
Democratic as each member has an equal say.
Disadvantages
For members who own a lot of shares they only get one vote.
Several Ways of Going Into Business
There are several ways of going into business and becoming an
entrepreneur. You can:
Purchase an existing business
Enter a family business
Start your own business
Buying an existing business
Advantages
Existing businesses already have customers, suppliers, and procedures.
Seller of the business may be willing to train the new owner.
There are existing financial records.
Financial arrangements may be easier.
Disadvantages
Business may be for sale because it is not making a profit.
Problems may be inherited with the purchase of an existing business.
May not have the capital needed to purchase an existing business .
Buying an existing business
Advantages
Existing businesses already have customers, suppliers, and
procedures.
Seller of the business may be willing to train the new owner.
There are existing financial records.
Financial arrangements may be easier.
Disadvantages
Business may be for sale because it is not making a profit.
Problems may be inherited with the purchase of an existing
business.
Many entrepreneurs may not have the capital needed to
purchase an existing business.
Starting Your Own Business
Advantages of Starting Your Own Business
Independence
Satisfaction
Challenge of creating something new
Triumph when business is profitable
Disadvantages of Starting Your Own Business
Risks
Uncertainty of demand for the product/service
Need to make decisions daily
Intellectual Property Rights
Intellectual property (IP) rights are the legally recognized exclusive
rights to creations of the mind. Under this law, owners are granted certain
exclusive rights to a variety of intangible assets.
It is a key element needed to maintain a competitive edge in the market.
Intellectual property are rights to protect your ideas or innovations
Types of Intellectual Property Rights
Common types of intellectual property rights include:-
Patents
Copyrights
Trademark
Trade secrets
Patent
It grants an inventor the right to exclude others from making, using,
selling, offering to sell, and importing an invention for a limited
period of time, in exchange for the public disclosure of the
invention.
For new and useful products and
For processes for the manufacture of new or existing products
Inventions patentable
Art, Process, Method or Manner of manufacture;
Machine, Apparatus or other Articles;
Substances produced by Manufacturing
Computer Software
Product Patent for Food/Chemical/Medicines or Drugs
Copyright
It provides exclusive rights to creative individuals for the
protection of their literary or artistic productions.
It covers literacy works (novels, poems, and plays), films, music
and etc.
Artistic works and other works containing intellectual content
such as library works, music, films, sound recordings, computer
programs are covered by copyright.
A copyright provides exclusive rights to creative individuals for
the protection of their literary or artistic productions.
Copyright means right not to be copied.
The copyright is indicated with the symbol ©
It gives the creator of original work exclusive rights to it, usually
for a limited time.
It means apply to a wide range of creative, intellectual or artistic
forms or work. For example
Trademark
It is a recognizable sign, design or expression which distinguished products
or services of a particular trades from the similar products or services of
other traders.
A trademark is a distinctive name, mark, symbol, or motto identified with a
company’s product(s) and registered at the Patent and Trademark Office.
Trademark is indicated with the written word “Trademark” or the symbol TM.
Trade Secret
Any confidential business information which provides an enterprise a
competitive edge may be considered a trade secret.
For example, Coca-Cola formula
Sources of finance
u r
f o
te r
a p
c h
o f
n d
E