Entrepreneurshi

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Chapter Three:
Business Formation
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 1. Introduction
• A business formation deals with the formalization and actual
implementation of business ideas in to practice.
• After completing this chapter, students will be able to:
Explain the Concept of Business and Forms of Business
Ownership;
Analyze the Importance/Role of MSEs;
Set Up Small Scale Business;
Distinguish the Failure and Success Factors of MSEs;
Identify the Problems of Small-Scale Business in Ethiopia; and
Develop Organizational Culture.
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 2. The Concept of Small Business
Development
• Specifying size and economic standard to
define small business is necessarily
arbitrary.
• Based on socio- economic conditions,
countries define small business differently.
But
Sizeall may use size
criteria and economic
Economic criteria criteria
as a base to
• Number of define small business.
• Market share,
employees Independence
• Startup capital • Personalized
management.

• MSEs cover a wider range of industries and

play an important role in both developed 3

and developing economies

 3. Forms of Business

• There are three basic legal forms of business formation

with some variations available depending on the
entrepreneurs’ needs.
• The three basic legal forms are: -
1. Proprietorship,
2. Partnership, and
3. Corporation,
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No Legal Forms Description
of Business

1 Proprietor Form of business with

ship single owner who has
unlimited liability,
controls all decisions, and
receives all profits.
2 Partnershi Two or more individuals
p having unlimited liability
who have pooled
resources to own a
business.
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3 Corporatio Separate legal entity that

• These three basic legal forms of business are compared with
regard to; • Liability; a claim
• Ownership, against the assets,
• Liability, or legal obligation
• Start-up costs, of a person or
• Continuity, organization.
• Transferability of interest, • Liabilities are
• Capital requirements, financial
• Management control, obligations of a
• Distribution of profits, and company or
• Attractiveness for raising capital. individual. 6
 4. MSEs in Developing Countries
4.1. Definition of
MSEs
• Small businesses are playing an important role in the industrial
economy of the world. These are particularly important in the
developing economies. Small business is predominant even in
developed countries such as USA, Japan etc.
• Specifying size and standard to define small business is
necessary because people adopt different standards for different
purposes.
• A business may be described as “small” when compared to
larger firms, but “large” when compared to smaller ones.
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There are two approaches to define small business.
They are: Size Criteria, and Economic/control criteria.
1. Size Criteria 2. Economic Criteria
• Size refers to the scale of • In addition to size, qualitative
operation. Some of the criteria characteristics may be used to
used to measure size are: differentiate small business
• Number of employees; from other business.
• Volume, and Value of sales  Market Share,
turnover,  Independence,
• Asset size, and Volume of  Personalized Management,
deposits,  Technology, and
• Total capital investment,  Geographical Area of Operation.
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• Volume/value of production,
and
 5. Classification of Micro and Small
Enterprises In Ethiopia
• Industry Enterprise includes Manufacturing, Construction and
Mining.
• Service Enterprise are Retailing, Transport, Hotel and Tourism,
ICT and Maintenance.

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 6.2. Environmental Analysis
I. Macro Environment II. Sectoral Analysis
• The macro environment of an • The purpose of industry
entrepreneur consists of the analysis is to determine what
political, technological, social, makes an industry attractive
legal and economic
indicated either by above
environments.
normal profits or high growth
• All of these are not immediate rates.
part of the entrepreneur’s
venture yet they have an impact • It is also advisable to study
on his/her enterprise. the existing or potential
competition, threat 23
of
substitutes and entry
 6.3. SWOT Analysis
A. Strengths; are positive internal
factors that contribute to an
individual’s ability to accomplish
his/her mission, goals and
objectives.
D. Threats; are negative external forces
B. Weaknesses; are negative that hinder an individual from
internal factors that inhibit an accomplishing his/her mission, goals
and objectives.
individual’s ability to accomplish
his/her mission, goals and o Threats in the environment can
arise from competition,
objectives.
technological breakthroughs,
C. Opportunities; are positive change in government policies etc.
external options that an
individual could exploit to 24

accomplish his/her mission, goals

7. Small Business Failure and Success
Factors
7.1. Small Business
Failure Factors
• Dun & Bradstreet, defines a business
failure as a business that closes as a result
of either
1. Actions such as bankruptcy,
foreclosure, or voluntary withdrawal
from the business with a financial loss
to a creditor; or
2. A court action such as receivership
(taken over involuntarily) or
reorganization (receiving protection 25

from creditors).
 7.2. Causes of Business Failure
o Inadequate o Inadequate
Management; Financing;
• For small business owners, • Shortage of capital.
management skills are especially
• Inadequate funds to start
desirable. Lack of experience is
business.
one of their most pressing
problems. • On the other hand, if you do
• The manager of a small business possess adequate capital but do
must be a leader, a planner, and a not manage your resources
worker. Ignoring other equally wisely, you may be unable to
important areas of the business, maintain adequate inventory or
such as record keeping, inventory, keep the balance needed to run
and customer service. the business.
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Other common causes of business
failure include Neglect, Fraud, and
Disaster.
• Neglect:- occurs whenever an owner doesn’t pay a
due attention to the enterprise.
• Fraud:- involves intentional misrepresentation or
deception.
 If one of the people responsible for keeping the
business’s books begins purchasing materials or goods
for himself or herself using the business's money.
• Disaster:- refers to some unforeseen happening.
 If a hurricane hits the area and destroys the property
in the company's yard and fires, burglaries, robberies,
or extended strikes.
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 • Reasons for a termination abound.
Business Termination  The owner may have an opportunity
Vs Business Failure to sell her business to someone else
There is a difference for a healthy profit.
between a business  S/he may have simply lost interest in
termination and a business the business.
failure.  The market for the business’s
product may have changed or
A termination occurs when become saturated.
a business no longer exists
 In other cases, businesses may
for any reason. A failure change form. A partnership may be
occurs when a business restructured as a corporation, or a
closes with a financial loss business may move to a new
to a creditor. location.
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 Mistakes Leading to Business Failure

• No one likes to think about failing, yet many

small business owners invite failure by
ignoring basic rules for success.
• One of the most common mistakes is to neglect
to plan for the future because planning seems
too hard or time-consuming.
• Another common mistake is failing to
understand the commitment and hard work
that are required for turning a business into a
success.
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 7.2. Small Business Success Factors
• Small businesses perform more efficiently than larger ones in
several areas.
For example, although large manufacturers tend to enjoy a
higher profit margin due to their economies of scale, small
businesses are often better at distribution.
• There are several positive steps in addition to planning that
business owners can take to improve a firm’s chance for
success. Those success factors are categorized as: -
1) Conducive Environment;
2) Adequate Credit Assistance; 31

3) Markets and Marketing Support.

 8. Main Supporting Packages for MSEs
Development in Ethiopia
• When entrepreneurs are deciding to involve and develop MSEs in
Ethiopia, they are more likely entitled with some supporting packages
which include
• Awareness creation about the sector;
• Provision of legal services, to form legal business enterprises;
• Providing Technical and business management training;
• Financial support based on personal saving, 20/80 (the
beneficiaries are save 20% and the MFIs provide Loan 80% of
the projects);
• Facilitate working premises; bookkeeping and audit services.
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9. Problems of Small-Scale Business
in Ethiopia
• Small-scale businesses have not been able to contribute
substantially to the economic development of Ethiopian
economy, particularly because of financial, production, and
marketing problems.
• Small scale enterprises find it difficult to get raw materials of
good quality at reasonable prices in the field of production.
• These problems are still major handicaps to their
development. Lack of adequate finance and credit has always
been a major problem of the Ethiopian small business.
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“Happiness lies in the joy of
achievement and the thrill of
creative effort.
Franklin D. Roosevelt
”

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