CHAPTER THREE

BUSINESS FORMATION

Contents
 The Concept of Small Business Development
 Forms of Business
 Definitions and Importance of SMEs
 Setting up Small Scale Business
 Small Business Failure and Success Factors
 Classification of Enterprises in Ethiopia
 Main Supporting Packages MSEs
Development in Ethiopia
 Problems of Small Scale Business in Ethiopia
 Organizational Structure & Entrepreneurial
Team Formation
 1. The Concept of Small Business Development
O Specifying size and standard to define small business is necessarily arbitrary, because

people adopt different standards for different purposes.

O Size and economic criteria as a base to define small business.

O Size criteria include number of employees and the startup capital.

O Size does not always reflect the true nature of an enterprise.

O Economic/control criteria covers market share, independence and personalized

management.
O Small and medium enterprises (SMEs) cover a wider spectrum of industries and play an

important role in both developed and developing economies.

O Small enterprises can start with less capital, enjoy quick returns, and have the flexibility to

handle the vagaries (change) of the market.

O Small enterprises have to face many problems like lack of finance, poor operations

management, lack of experience, poor financial management, etc.

 2. Forms of Business
Basic Forms of Business Formation
Factors
Proprietorship Partnership Corporation

Ownership Individual No limitation on number of No limitation on number of

partners stockholders
Liability of Individual liable -In general partnership-all Amount of capital
owners for business individuals liable for business contribution is limit of
liabilities liability shareholder liability
-limited partners are liable for
amount of capital
contribution
-In limited liability
partnership-there is no
liability except when
negligence exists
start up cost None, other Partnership agreement, legal -Created only by statute
than filing fees costs and minor filing fees for -Articles of incorporation,
for trade name trade name filing fees, taxes and fees for
states in which corporation
registers to do business
 Cont…
Factors Basic Forms of Business Formation
Proprietorship Partnership Corporation
Continuity Death dissolves -Death or withdrawal of one -Greatest form of continuity
of business the business partner terminates partnership -death or withdrawal of
unless partnership agreement owner(s) will not affect legal
stipulates otherwise. existence of business
Transferabil Complete -General partner can transfer Most flexible. Stockholders
ity of freedom to sell his/her interest only consent of can sell or buy stock at will.
interest or transfer any all other general partners Some stock transfers may be
part of business -Limited partner can sell restricted by agreement.
interest without consent of
general partners. No transfer
of interest in an LLP.
Capital Capital rose only -Loans or new contributions New capital raised by sale of
requirement by loan or by partners require a change in stock or bonds or by
s increased partnership agreement borrowing (debt) in name of
contribution by -In LLP, entity raises money. corporation.
proprietor.
 Cont…
Factors Basic Forms of Business Formation
Proprietorship Partnership Corporation
Managemen Proprietor makes -All general partners have -Majority stockholder(s) have
t control all decisions and equal control, and majority most control from legal point
can act rules of view.
immediately -Limited partners have limited -Day to day control in hands
control. of management, who may or
-Can vary in an LLP (limited may not be major
liability partnership). stockholders.
Distribution Proprietor Depends on partnership Shareholders can share in
of profits responsible and agreement and investment by profits by receipt of
and losses receives all partners. dividends.
profits and losses
Attractivene Depends on Depends on capability of With limited liability for
ss for capability of partners and success of owners, more attractive as an
raising proprietor and business. investment opportunity.
capital success of
business.
 3. Definitions and Importance of SMEs
 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.

 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.
 Size(employees fewer than 100, in rare cases owners may have more than 15 or 20) and

economic/control criteria are used to define small businesses.

Economic criteria includes:
 Market share- It is not large to influence the price in the market.

 Independence-the owner controls the business himself/herself.

 Personalized management-the owner actively participates in all areas of management.

 Technology- mostly they are labor intensive

 Geographical area of operation-local operation but may have some global markets.
 Cont…

Small and medium enterprises (SMEs) cover a wider spectrum of industries and play an important role.
O Large Employment Opportunities
O Economical Use of Capital
O Balanced Regional Development/ Removing Regional Imbalance
O Equitable Distribution of Wealth and Decentralization of Economic Power: removes the drawbacks

of capitalism, abnormal profiteering, concentration of wealth and economic power in the hands of few

etc.
O Unregulated Growth of Large-scale industries results in concentration of economic· power in the

hands of a few; and consequently, gross inequalities in the distribution of income and wealth will occur.

O Dispersal over Wide -Mobilization of Locals Resources/Symbols of National Identity

O Higher Standard of Living -Innovative and Productive /Simple Technology
O Less Dependence on Foreign Capital/ Export Promotion
O Promotion of Self Employment -More Employment Creation Capacity :
O Facilitate Development of Large Scale Enterprises -Shorter Gestation Period
O Individual Tastes, Fashions, and Personalized Services -Protection of Environment
 4. Setting up Small Scale Business
The entrepreneurial process of launching a new venture can be divided
into three key stages of: Discovery; Evaluation; and Implementation.
 Discovery: discovering entrepreneurial potential and identifying a

problem & potential solution-identifying opportunities.

 Evaluation: evaluating the idea as a business opportunity and

investigating & gathering the resources-analyzing and selecting the

opportunity.
 Implementation: forming the enterprise to create value,
implementing the entrepreneurial strategy and planning the venture-
launching and developing the enterprise.
Macro environment, Sectoral Analysis, SWOT Analysis and Product
or Service must be assessed to launch the final venture.
 5. Small Business Failure and Success Factors
Business failure may be happened as result of either
O Bankruptcy, foreclosure, or voluntary withdrawal from the business with a financial loss to a creditor;

O A court action such as receivership (taken over involuntarily) or reorganization (receiving protection

from creditors).

Causes of Business Failure Business Success

Conducive Environment
Inadequate Management
Inadequate Financing Adequate Credit Assistance
Neglect, Fraud and Disaster Markets & Marketing Support

Mistakes leading to business failure

O Improper planning

O Lack of commitment and hard working

O Ineffective use of employees and lack of timely recruitment of employees

O Inaccurate estimates of cash flow and capital requirements

 6. Classification of Enterprises in Ethiopia

In Case of Manufacturing Enterprise (Manufacturing, Construction and Mining):

O A Micro Enterprise is one in which the investment in plant and machinery (total asset)

does not exceed birr100, 000 (one hundred thousand); and operates with 5 people including

the owner.
O Small Enterprises is one in which the investment in plant and machinery (a paid up capital

of total asset) of birr100, 000 (one hundred thousand) and not more than Birr 1.5 million;

and operates with 6-30 persons.

In Case of Service Enterprise (Retailing, Transport, Hotel and Tourism, ICT and

Maintenance):
O A micro enterprise is one with the values of total asset is not exceeding Birr 50,000(fifty

thousands); and operates with 5 persons including the owner of the enterprise.
O Small Enterprises is one in which the total asset value or a paid up capital of birr100, 000

(one hundred thousand) and not more than Birr 1.5 million; and operates with 6-30 persons.
 Cont…
Priority Sectors and Sub-Sectors for MSEs Engagement In Ethiopia
O Manufacturing Sector-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.
O Construction Sectors- sub-contracting; building materials; traditional mining works; cobble

stone; infrastructure sub-contract; and prestigious goods

O Trade Sectors- whole sale of domestic products; retail sale of domestic products and raw

materials supply.
O Service Sectors- 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 and internet café.

O Agriculture Sector (Urban Agriculture)-livestock raring; bee production; poultry; modern

forest development; vegetables and fruits; modern irrigation; and animal food processing.
 Cont…

Levels of MSEs in Ethiopia

O Start-up:- an enterprise begins production and service under legal framework or legal entity.
O Growth Level:- become competent in price, quality and supply and profitable using the support

provided; and use book keeping system.

O Maturity Level:- able to be profitable and invest further by fulfilling the definition given to the

sector and using the support provided.

O Growth- Medium Level:- transformed from small to medium level.
7. Main Supporting Packages 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); -bookkeeping and audit services.
 industry extinction services and BDS provision; -facilitate working premises;
 8. Problems of Small Scale Business in Ethiopia
 Lack of adequate finance and credit has always been a major problem of
the Ethiopian small business.
 Small scale enterprises find it difficult to get raw materials of good quality
at reasonable prices in the field of production.
 The techniques of production, which the enterprises have adopted, are
usually outdated.
 Because of their poor financial position they are not able to buy new
equipment, consequently their productivity suffers.
 Small business’s owner can avoid some of the common pitfalls that lead to
business failure by knowing the business in depth; developing a solid
business plan; managing financial resources; understanding financial
statements; and learning to manage people effectively.
 9. Organizational Structure & Entrepreneurial Team Formation

Design of the organization will be the entrepreneur’s formal and explicit indication to the members of the

organization as to what is expected of them. It includes:

O Organization structure-defines members’ jobs and the communication and relationship these jobs

have with each other. These relationships are depicted in an organization chart.
O Planning, measurement, and evaluation schemes- 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.

O Rewards- rewards in the form of promotions, bonuses, praise, and so on.
O Selection criteria- determine a set of guidelines for selecting individuals for each position.
O Training- on or off the job, formal education or learning skills and must be specified.

Building the Management Team and a Successful Organization Culture

O Execute the business plan;
O Identify fundamental changes in the business as they occur; and
O Make adjustments to the plan based on changes in the environment and market that will maintain

profitability.