CHAPTER 2

BUSINESS FORMATION
By:
Habib S.(MBA in International Business)
INTRODUCTION

A business formation deals with the

formalization and actual implementation
of business ideas in to practice.
In today’s economic development/transformation,
small businesses are creating new jobs even as
large businesses continue eliminating jobs and
they are more flexible than large ones in the
products and services they offer.
This chapter discusses the issues of business
development and the different legal forms of
business.
In addition, the concept of MSEs in the Ethiopian
and international context are discussed.
 THE CONCEPT OF SMALL
BUSINESS DEVELOPMENT
Based on socio- economic conditions, countries
define small business differently.
But all may use size and economic criteria as a base
to define small business.
Size criteria include number of employees and the
startup capital.
Size does not always reflect the true nature of an
enterprise; in addition, qualitative characteristics are
used to differentiate small business from other
business.
The economic/control definition covers
market share, independence and
personalized management.
Micro and small enterprises (MSEs) cover a
wider spectrum of industries and play an
important role in both developed and
developing economies.
Ethiopia is no exception and MSEs occupy
a prominent position in the development of
the Ethiopian economy.
Entrepreneurs have to face many
problems like lack of finance, poor
operations management, lack of
experience, poor financial management,
etc,.
The process of setting up a venture
begins with searching for an opportunity.
Identifying a good opportunity is a
difficult task and involves scanning the
environment and the use of creativity
 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, with variations particularly in
partnerships and corporations.
These three basic legal forms are compared
with regard to ownership, liability, start-up
costs, continuity, transferability of interest,
capital requirements, management control,
distribution of profits, and attractiveness for
raising capital.
DEFINITION AND ROLE/
IMPORTANCE OF MSES IN
DEVELOPING COUNTRIES
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
There is a difference between small business
owners and entrepreneurial ventures as well.
An entrepreneurial venture often is a growth-
oriented innovative company with product or
service offerings that are new to the market.
Small businesses could be entrepreneurial
ventures. Most entrepreneurial ventures start
as a small business.
However, some discernible characteristics
still differ them.
Most small businesses’ owners work with
known products and services aimed at
incremental growth, and their innovation is
focused on sales, marketing, and market
expansion.
Entrepreneurial ventures incorporate a different
set of strategies.
These entities are aimed at rapid growth and
apply innovation and creativity at every node of
the business process.
They work with new offerings, and they face a
lot more uncertainties; hence, their strategy
calls for continuous work on mitigating
uncertainty and risk reduction.
 SIZE CRITERIA
Even the criteria used to measure the size of
businesses vary; size refers to the scale of operation.
Some criteria are applicable to all industrial areas,
while others are relevant only to certain types of
business.
For instance, some of the criteria used to measure
size are: number of employees; volume, and value of
sales turnover, asset size, and volume of deposits,
total capital investment, volume/value of production,
and a combination of the stated factors.
Even though the number of employees-is
the most widely used yardstick, the best
criterion in any given case depends upon
the user’s purpose.
To provide a clearer image of the small firms, the following general
criteria for defining a small business are suggested by Small
Business Administration (SBA).
Financing of the business is supplied by one individual or a small
group. Only in a rare case would the business have more than 15 or
20 owners.
Except for its marketing function, the firm’s operations are
geographically localized.
Compared to the biggest firms in the industry, the business is small.
The number of employees in the business is usually fewer than 100.
This size criteria based definition of MSEs
varies from country to country.
All over the world, number of employees or
capital investment or both has been used
as the basis for defining MSEs.
 ECONOMIC/CONTROL CRITERIA.

The economic/control definition covers:

Market Share- is not large enough
Independence- means the owner has control of
the business himself/herself.
Personalized Management-It implies that the
owner actively participates in all aspects of the
management of the business
Geographical Area of Operation-The area of
operation of a small firm is often local
ROLE/IMPORTANCE OF MSES IN
DEVELOPING COUNTRIES
1) Large Employment Opportunities
2) Economical Use of Capital-needs small
amount of capital
3) Balanced Regional Development/
Removing Regional Imbalance
4) Equitable Distribution of Wealth and
Decentralization of Economic Power
5) Unregulated Growth of Large-scale
industries results in concentration of
economic power in the hands of a few
resulting in an income inequalities.
On the other hand; income generated in a
large number of small enterprises is
dispersed more widely and its benefit is
derived by the large segments of the society.
6) Dispersal over Wide Areas
7) Higher Standard of Living
8) Mobilization of Locals Resources
9) Innovative and Productive /Simple
Technology
10) Less Dependence on Foreign Capital/
Export Promotion
11) Promotion of Self Employment
CLASSIFICATION OF MICRO AND
SMALL ENTERPRISES
When ambiguity is encountered between
manpower and total assets as explained
above, total asset is taken as primary
yardstick.
PRIORITY SECTORS AND SUB-
SECTORS FOR MSES ENGAGEMENT
IN ETHIOPIA
Manufacturing Sector- comprises
textile and garment;
leather and leather products;
food processing and beverage;
metal works and engineering wood works
including furniture and ornaments service; and
agro-processing.
CONSTRUCTION SECTORS
This is the one which comprises
sub-contracting;
building materials;
traditional mining works;
cobble stone;
infrastructure sub-contract
TRADE SECTORS
This is the one which comprises whole
sale of domestic products; retail sale of
domestic products and raw materials
supply.
SERVICE SECTORS
This is the one which comprises small and
rural transport service;
café and restaurants;
store service; tourism service;
canning/packing service;
management service; municipality service;
project engineering service;
product design & development service;
maintenance service; beauty salon; and
electronics software development; decoration
AGRICULTURE SECTOR (URBAN
AGRICULTURE)
This is the one which comprises modern
livestock raring; bee production; poultry;
modern forest development; vegetables
and fruits; modern irrigation; and animal
food processing.
 LEVELS OF MSES IN ETHIOPIA
1. Start-up:- Start up level refers to enterprises that
incorporate people who are interested to establish
MSE and those who completed the required
profession/skill from various institutions and
innovated by legally either in the form of association
or private.
2. Growth Level: - An enterprise is said to be at growth
level when an enterprise become competent in price,
quality and supply and profitable using the support
provided.
At this level, the enterprise man power and total asset
is larger than at startup level; and use book keeping
3. Maturity Level: - Maturity level means
when an enterprise able to be profitable
and invest further by fulfilling the
definition given to the sector and using
the support provided.
SETTING UP SMALL SCALE
BUSINESS
Steps for Setting up the Entrepreneurial Venture
Once an individual decides to take up
entrepreneurship as a career path, to be a job
provider instead of a job seeker, s/he has to
establish an enterprise.
However, setting up of a small new enterprise
is a very challenging as well as a rewarding
task.
CONT…

The entrepreneurial process of launching a

new venture can be divided into three key
stages.
1. Discovery;
2. Evaluation; and
3. Implementation. These can be further sub-
divided into seven steps as shown below:
ENVIRONMENTAL
ANALYSIS
Entrepreneurship does not exist in a
vacuum. It is affected by and affects the
environment. Relationship between
entrepreneurship and environment is
shown in the figure below.
ENTREPRENEURSHIP & ENV.T
CONT…

As the economies are getting

internationally integrated, for an analysis
of the environment of entrepreneurship
you would be required to develop an
understanding of macroeconomic, and
industry/sector specific factors.
MACRO ENVIRONMENT
The macro environment of an
entrepreneur consists of the political,
demographic, technological, social-
cultural, legal and economic
environments.
All of these are not immediate part of
the entrepreneur’s venture yet they have
an impact on his/her enterprise.
SECTORIAL/INDUSTRY
ANALYSIS
The purpose of industry analysis is to
determine what makes an industry attractive-
this is usually indicated either by above normal
profits or high growth rates.
For such analysis one should study the history
of the industry, the future trends, new products
developed in the industry, forecasts made by
the government or the industry.
It is also advisable to study the existing or
potential competition, threat of substitutes and
entry barriers.
SWOT ANALYSIS

Used to identify
Strength/competences and weakness
Opportunity and threat
SMALL BUSINESS FAILURE AND SUCCESS
FACTORS

Small Business Failure Factors

Dun & Bradstreet, a financial research firm, defines a
business failure as a business that closes as a result of
either.
actions such as bankruptcy, voluntary withdrawal from the
business with a financial loss to a creditor/insolvency.
 a court action such as receivership/insolvency (taken over
involuntarily) or reorganization (receiving protection from
creditors).
CAUSES OF BUSINESS
FAILURE
The rates of business failure vary greatly by
industry and are affected by factors such as
type of ownership, size of the business, and
expertise of the owner.
The causes of business failure are many and
complex; however, the most common causes
are inadequate management and financing.
OTHER COMMON CAUSES OF
BUSINESS FAILURE INCLUDE
Neglect(Fail to care about)
Fraud(Illegal obtaining of money)and
Disaster(Unexpected physical damage).
 NEGLECT

Neglect occurs whenever an owner

does not pay a due attention to the
enterprise.
The owner who has someone else
managing the business while s/he goes
fishing often finds the business failing
because of neglect.
 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, the business might find
itself bankrupt before too long.
 DISASTER.

Disaster refers to some unforeseen

happening. If a hurricane/cyclone hits the
area and destroys the property in the
company's yard, the loss may require the
firm to declare bankruptcy.
The same is true for fires, burglaries,
robberies, or extended strikes.
 BUSINESS TERMINATION
VERSUS FAILURE
There is a difference between a business
termination and a business failure.
A termination occurs when a business no
longer exists for any reason/if it already
achieved its mission/purpose.
A failure occurs when a business closes
with a financial loss to a creditor or due to
insolvency.
SMALL BUSINESS SUCCESS FACTORS
These success factors are categorized as:-
1. Conducive Environment-
conducive political climate/liberal/good investment climate,
economic env.t, technology and socio-cultural conduciveness
2. Adequate Credit Assistance-
requirements are less strict in terms of lower interest rates than the
prevailing commercial rates; less collateral requirements and lower
equity ratio; various assistance schemes such as preparing the
project study; etc.
3. Markets and Marketing Support- The government too can take an
active part in marketing specific products or assisting small groups of
entrepreneurs in selling their products.
MAIN SUPPORTING PACKAGES
FOR MSES DEVELOPMENT IN
ETHIOPIA
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
Book keeping and audit services.
PROBLEMS OF SMALL SCALE
BUSINESS IN ETHIOPIA
Small-scale businesses have not been able
to contribute substantially 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 the
Ethiopian small business.
ORGANIZATIONAL STRUCTURE AND
ENTREPRENEURIAL TEAM
FORMATION
Introduction
We can perceive from the experiences
of companies the importance of
employees and their loyalty and
commitment to the organization.
Also significant to potential investors is
the management team and its ability and
commitment to the new venture.
DESIGNING THE
ORGANIZATION
Generally, the design of the initial
organization will be simple.
In fact, the entrepreneur may find that he
or she performs all the functions of the
organization alone.
This is a common problem and a
significant reason for many failures.
DESIGNING THE
ORGANIZATION,,,,,
The entrepreneur sometimes thinks that he or
she can do everything and is unwilling to give
up responsibility to others or even include
others in the management team.
In most cases when this occurs, the
entrepreneur will have difficulty making the
transition from a start-up to a growing, well-
managed business that maintains its success
over a long period of time.
DESIGNING THE
ORGANIZATION,,,,,
Regardless of whether one or more
individuals are involved in the start-up,
as the workload increases, the
organizational structure will need to
expand to include additional employees
with defined roles in the organization.
Effective interviewing and hiring
procedures will need to be implemented
to ensure that new employees will
effectively grow and mature with the new
DESIGNING THE
ORGANIZATION,,,
All the design decisions involving
personnel and their roles and
responsibilities reflect the formal
structure of the organization.
DESIGNING THE
ORGANIZATION,,,,,
Organization structure- This defines
members’ jobs and the communication
and relationship these jobs have with
each other.
These relationships are depicted in an
organization chart.
DESIGNING THE
ORGANIZATION,,,,,
Planning, measurement, and evaluation
schemes- All organization activities
should reflect the goals and objectives
that underlie the venture’s existence.
The entrepreneur must spell out how
these goals will be achieved (plans), how
they will be measured, and how they will
be evaluated.
 DESIGNING THE ORGANIZATION,,,,,
Rewards- Members of an organization will require
rewards in the form of promotions, bonuses,
praise, and so on. The entrepreneur or other key
managers will need to be responsible for these
rewards.
Selection criteria- The entrepreneur will need to
determine a set of guidelines for selecting
individuals for each position.
Training- Training, on or off the job, must be
specified. This training may be in the form of
formal education or learning skills.
 ORGANIZATION CULTURE

After designing the organization and

building the management/Entrepreneurial
team the next is creating a successful and
sound organizational culture.
 ORGANIZATION CULTURE,,,
The organization culture is a blend of
attitudes, behaviors, dress, and
communication styles that make one
business different from another.
There is no specific technique for
accomplishing this since every
organization will be different.
 ORGANIZATION CULTURE,,,
All in all, finding the most effective team
and creating a positive organization
culture is a challenge for the
entrepreneur but is just as critical as
having an innovative, marketable product.
It is an important ingredient in an
organization’s success
Thank you !!!!!!!