Revision on Ch-1

Basic concepts on Entrepreneur &

entrepreneurship

Characteristics & Skills of Entrepreneurs

Motivation for starting a business

Success factors for entrepreneurs

Outcomes of Entrepreneurship
Weakness of Entrepreneurship
 Revision on Ch-2
Business Planning
 Opportunity Identification and
Evaluation
 Business Idea Development Ideas
 The Concept of Business Planning
 Business Feasibility
 The Business plan
 Chapter-3

Business Formation

3
 CHAPTER FOUR
Welcome to business legal forms

4
 Part Four: Choosing The Legal Form Of an
Ownership

4.1 Introduction
4.2 Forms of Ownership and legal requirement
4.3 Advantage and disadvantage for each types of
ownership

5
 Introduction
 Entrepreneurs have a vision about what a business might be like.
When thinking about the positives, the vision is probably one of
good fortune and success. But, as you can imagine,
 unfavorable things may happen
 Revenues may not be enough to pay all the bills
 accidents can happen, and many other contingencies may mean the
entrepreneur has financial responsibilities that must be met.
 The legal form under which the firm operates can have an impact
on the financial position of the entrepreneur.

6
 Forms of ownership and legal requirements
 Though it is difficult to know precisely when and how business
began, it is certain that the form of business ownership are as old
as business itself. Those forms have been modified over the
course of time to keep pace with business needs and the custom
of society.

 Ownership of business is represented by the right of individual

or a group of individuals to acquire legal title to property
(assets) for the purpose of controlling them and to enjoy the gains of
profits from such possession and use.

 Once you decide to start your own business, you must decide
7 what type of ownership the business will have.
  The most common forms currently in wide use are:
 Sole proprietorship
 Partnership
 Corporations and
 Cooperatives
 A business that is owned exclusively by one person is a sole proprietorship.
 A business owned by two or more people is a partnership.
 A business with the legal rights of a person and which may be owned by many people
is a corporation.
 Each form of ownership has a characteristic internal
structure, legal status, size and field to which it is best suited.
 Each has key advantages and disadvantages.

8
 1) Sole proprietorship
 It is an individual or single ownership
 The sole proprietorship is a form of business organization in which
o An individual introduces his capital,
o Use of his own skill and intelligence in the management of its
affairs and
o It is solely responsible for the results of its operation.

 This form is known also as individual or single proprietorship, sole

ownership or individual enterprise.

 Example: Photo studio, bookshop, bakeries, small town restaurants,

retail stores, radio and watch repair shops, and other elementary
forms of business where personal service is important.

9
 Advantages of Sole proprietorships

a. Ease and low cost of formation and dissolution:-there are no

restrictions on either starting or terminating small business
operations.
b. Direct motivation and personal care
c. Freedom and promptness of action
The sole proprietor can take his own decision and there is none to
question his authority. the sole proprietor can take prompt/quick
decisions especially when an emergency arises.
d. Business confidentiality
e. Single Tax:-The proprietorship does not pay tax as a business; the
profits from the business are the personal income of the owner and are
declare on his individual income tax return.

10
 Disadvantages of sole proprietorship

a. Limited resources and size:-the capacity and skill are very limited.
Lending institutions and suppliers may not be willing to cooperate
because it is neither safe nor dependable which results in making the
business to remain limited in size.

b. Limited Managerial Skill:- in complex and difficult condition which

requires different expertise knowledge

c. Unlimited liability:-The sole proprietor will be legally liable for all

debts of the business , a source of courage and real devotion, limit his
activities only in specified areas

d. Uncertain future/Death of the owner terminates the business/

e. Difficulty in hiring and keeping high achievement employees

11
 2. Partnership
 The association of two or more persons to carry as co-owners of
a business where the relationship is based on agreement is
called partnership.

 This form of a business requires the existence of two or more

persons entering into a contractual relationship.

 This contract, which is an agreement between the parties, is

known as a memorandum of association or article of
partners’ deed.

12
 Kinds of Partners
1.A general partner
 Assumes unlimited liability and is usually active in managing the business. Most
partners are general partners.
2.A limited or special partner
 Assumes limited liability, risking only his /her investment in the
business. Limited partners may not be active in management, and their
names are not used in the name of the business.
3.A secret partner
 Takes an active role in managing a partnership but whose identities are
unknown to the public. i.e the general public does not know of this person’s
partnership status.
4.A silent partner
 As opposed to a secret partner, a silent partner, his identities and involvement,
is known to the general public, but is inactive in managing the partnership
13
business
 5.Senior partners
 Assume major roles in management because of the long tenure
(possession), amount of investment in the partnership, or age. They
normally receive large shares of the partnership’s profits.

6.Junior partners
 Are generally younger partners in tenure, have only small investment in
the firm, and are not expected to make major decision. They assume
limited role in the partnership’s management and receive a smaller
share of the partnership’s profits.
7. Nominal partner:
 A nominal partner is one who lend his name to the firm as a partner.
Such partner does not invest any capital nor he participates in
management. However, his liability towards third parties is just like the
other general partners.
14
See others…depends on country specific laws…
 Advantages of partnership
1. Ease of starting
2. Increased source of capital:-Partnership can offer creditors less
risk than a sole proprietorship; it is often an attractive investment.
3. Combined managerial skill
4. Definite legal status
 Today’s partner can be assured that a competent lawyer can answer
virtually any questions he/she might have about this form of
ownership. i.e lawyers can provide a sound legal advice about
partnership issues.
6. Motivation of important employees
7. Reduced risk

15
 Disadvantages of partnership
1.Unlimited liability
2. Risk of implied authority
 The fault and miss judgment made by a single partner binds the
firm and the remaining partners. Thus, they are liable for the
debts made by the partner.
3. Lack of harmony…agrmnt or synchronizatn
4. Lack of continuity/instability/
 If any one of the general partners dies, withdraws because of
mentally or physically incapable (injured), the partnership ends.
5. Investment withdrawals difficulty /frozen-investment/

16
 3. Corporation

 A corporation is an artificial person authorized and recognized by

law, with distinctive name, a common seal, comprising of
transferable shares of fixed values, carrying limited liability and
having a perpetual or continued or uninterrupted succession
life.

17
 Characteristics of Corporation
1. Separate legal entity
 It can sue or be sued.
 It has the right to manage its own affairs.
 Shareholders cannot be liable for the acts of the corporation
2. Limited liability
 Since the corporation has separate legal entity its debts are its own. The
assets and liabilities, rights and obligations incidental to the company’s
activities are assets and liabilities, rights and obligations respectively of the
company and not of its members.
3.Transferiablity of shares
 It is easy to transfer ownership in a corporation. A stockholder may sell
stock to another person and transfer the membership and membership
interest freely without consulting other stockholders.
18
 4.Perpitual existence
 Death, insanity, retirement and withdrawal of shareholders will not
affect the company.
5.Common seal
 A corporation has a common seal with the name of the company
engraved on it, which is used as a substitute for its signature
through it acts through its agents.
6.Separation of ownership from management
7.Supervision
8.Written Constitution
 On the creation of a company, the promoters must file certain
documents with the Registrar of Companies. These include the
Article of Association and the Memorandum of Association.
19
 Advantages of a corporation
1. Financial strength
2. Limited liability
3.Scope of expansion
 Corporations have greater potential than sole proprietorship or
partnerships
4. Managerial efficiency
 Corporations enjoy the advantage of efficient management by hiring
specialist’s skilled persons to become members of the board of
directors to mange the corporation
5. Ease in transferring ownership
6. Legal entity status
A corporation can purchase property, make contracts, sue and
be sued in the corporate name.
20
 Disadvantages of a corporation
1. Difficulty of formation
 It is time consuming and cumbersome/not managable to establish
corporations unlike the other forms of businesses.
2. Lack of owner’s/manager’s personal interest
 These forms of organizations are managed by directors, hired
officials, and employees who may not be expected to have such an
interest in the success of the business as the individual owner or
partner would have in his own business.
3. Delay in decision-making…it needs official meeting of managers or board
4.Lack of secrecy….openness…lack of privacy
5.Double taxation

21
 Cooperative
 It is an organization owned by members/customers who pay an
annual membership fee and share in any profits (if it is profit
making organization).

 This is where people associate on a voluntary basis to promote

their economic interests, whereby resources are pooled together
and used. People with financial constraints, especially, tend to
form co-operatives to benefit from joint efforts and external
support facilities.

22
 Cooperative…

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

23
 5.Other forms of business
Franchises
 A franchise is a business in which the owner of the name or
method of doing business (called the franchisor) allows a local
operator (called the franchisee) to set up a business under that
name.

Management buy-outs and buy-ins

 In recent years the traditional separation of shareholders and
management has been eroded by the growing popularity of
management buy-outs’. This is where a group of members pool
their resources to buy the business they have been running, usually
from as larger, parent company. A management buy-in is where a
group of managers buys into an existing firm, usually replacing
24 those who have been running it.
 Forms of ownership…Ethiopian
practice

 See Ethiopian case

25
 Legal form of Business organizations in Ethiopia

The Commercial Code of Ethiopia defines a business organization as

follows: "A Business organization is any association arising out of a
partnership agreement."
According to this definition there are eight forms of business
organizations:
 Ordinary partnership;
 Joint venture;
 General partnership;
 Limited partnership;
 Share company;
 Private limited company;
 Sole proprietorship;
26  Co-operative.
 Ethiopian case…
 Each form of business stated above has its own advantages
and disadvantages.You can make your choice based on the
following factors:
Ease of registration;
Number of owners;
Financial responsibility of owners;
Degree of freedom in decision making; and
Mode of tax payment.

 For more information on forms of business organizations

and their establishment, refer to the Commercial Code of
27
Ethiopia (1960).
 Brief summary of the common business forms of ownership

Sole Proprietorship Individual

1. Ownership
Partnership No Limit On Number Of Partners

Corporation No Limit On Number Of Shareholders

2. Liability of Owners

Sole Proprietorship Individual Liable For Business Liabilities

Partnership- General All Individuals Liable For All Business Liabilities

Partnership- Limited Limited Partners Liable For Amount of Capital Contribution

Corporation Shareholders Liable For Amount Of Capital Contribution

28
 Brief summary …

Sole Proprietorship Trade Name Filing Fees

3. Cost To Start Partnership- General Partnership Agreement, Legal Costs, Trade Name Filing Fees
Partnership- Limited More Comprehensive Partnership Agreement

Corporation Created By Statute, Articles Of Incorporation, Filing Fees,

Taxes, Fees for States In Which Corporation Registers To Do
Business

4. Continuity Of Business
Sole Proprietorship Death Dissolves Business

Partnership- General Death/Withdrawal Of 1 Partner Terminates Business Unless

Partnership- Limited agreement Stipulates Otherwise
Death/Withdrawal Has No Effect On Continuity

Corporation Death/Withdrawal Of Owner Has No Effect On Continuity

29
 Brief summary …
5. Transferability Of Interest
Sole Proprietorship Complete Freedom To Sell/Transfer

Partnership- General General Partners Can Transfer Only with Consent Of All Other
Partnership- Limited General Partners
Limited Partners Can Sell Interest Without Consent of General
Partners

Corporation- Regular Shareholders Can Sell/Buy Stock At Will. Some Transfers Might Be
Corporation- S Restricted.
Shareholder Can Only Sell Stock To An Individual.

6. Management Control
Sole Proprietorship Owner Makes All Decisions

Partnership- General All Partners Have Equal Control, Majority Rules

Partnership- Limited Only General Partners Have Control Of Business

Corporation Majority Shareholders Have Control. Day-To-Day Control With

30 Management
7. Distribution Of Profits Brief summary …

Sole Proprietorship Owner Receives All Profits/Losses

Partnership Distributed According To Agreement & Capital Contribution

Corporation Shareholders Received Profits Through Dividends

8. Tax Attributes
 Sole Proprietorship = Owner
 No Double Tax
 No Capital Stock/Retained Earnings Penalty

 Partnership
 Limited Partners = Share Of Profits But No Liability
 Income Distributed Based On Agreement

 Corporation = Separate Entity

 More Deductions/Expenses Available
31
 Double Taxation Of Dividends
 Summary…
Generally, the most attractive form of business ownership meets the
specific needs of the business and its owners in these eight areas:
1. Tax considerations
2. Liability exposure
3. Start-up and future capital requirements
4. Control
5. Managerial ability
6. Business goals
7. Management succession plans
8. Cost of formation
Business owners may need to make concessions due to the trade-offs
32
associated with eight these factors.
 summary…

 It is important that every new business enterprise

should be registered under one of the legal forms of
business ownership.
 The entrepreneur should therefore decide the form
of business ownership that would be appropriate for
his/her new business venture.

 Reading Assignment
Commercial code (1960, Ethiopia)
33
 Thank you
for Today

34
 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
 Purchase a franchise
 Start your own business

 Read the advantages and disadvantages of these alternatives

35
 ways of going into 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.
36
 Introduction…
 Entering a family business
Advantages
 There is a certain sense of pride and accomplishment that comes from being part of a
family endeavor.
 A business can remain in the family for generations.
 Some people enjoy working with relatives.
 The efforts of running a family business give one the benefit of knowing that their efforts
are helping those whom they care about.
Disadvantages
 Senior management positions are often held by family members who may not be the best
qualified.
 It may be difficult to retain qualified employees who are not members of the family.
 Family politics may affect decisions regarding the business.
 It is often difficult to separate business life and private life in family-run businesses.
 It is often difficult to set policies and procedures and to make decisions.
37
 Introduction…
Franchise Ownership
 A franchise is a legal agreement that gives an individual the right
to market a company’s products or services in a particular area.
 The two parties to a franchise agreement are the franchisor, the
parent company of a franchise agreement that provides the
produce/service, and the franchisee, the distributor of a
franchised product/service
Advantages of purchasing a franchise business
 An established product or service is being provided.
 Franchisors often offer management, technical, and other
assistance.
 Equipment and supplies may be less expensive.
 A guarantee of consistency attracts customers.
38
 Franchise Ownership….
Introduction…
Disadvantages of purchasing a franchise business
 The cost of franchises may be high, which can reduce profits.
 Franchise owners are limited in the decisions they can make regarding the
business.
 The performance of other franchises impact on the franchisee.
 The franchise agreement may be terminated by the franchisor.
Operating Costs of a Franchise
 The initial franchise fee is the fee the franchise owner pays in return for
the right to run the franchise.
 Start-up costs are the costs associated with beginning a business.
 Royalty fees are weekly/monthly payments made by the owner of
franchise.
 Advertising fees are fees paid to support advertising of the franchise as a
39
whole.
 Introduction…
 Starting Your Own Business
 For whatever reason, running an existing business or operating a franchise
may not be right for you. This means to be an entrepreneur you will have
to establish a business of your own.
 Advantages of Starting Your Own Business
 Independence
 Satisfaction
 Challenge of creating something new
 Triumph/victory when business is profitable
 Disadvantages of Starting Your Own Business
 RISKS
 Uncertainty of demand for the product/service
 Need to make decisions daily

.
40
 Small Business as an important part of Economy
What is small business?
To provide a clear image of the small firms, the following general
criteria for defining a small business are suggested:
A). Financing of the business is supplied by one individual or a small
group.
b) Except for its marketing function, the firm’s operations are
geographically localized.
c) Compared to the biggest firms in the industry is small
d) The number of employees in the business is usually fewer than
100

According to a recent World Bank Survey, out of 733 Ethiopian firms:

measured by sales and assets: 76% are small; 18% medium; and
41 6% large [Source: Bas,T. (2012)]
 There are two approaches to define small Business. They are:
1. By some measure of size
2. using an economic /control definitions.

1. Size Criteria
Examples of criteria used to measure size are:
1. Number of employees 2. Sales volume
3. Asset size 4. Insurance enforce
5. Volume of deposits

 Although the first criteria located above, employee, is the most

widely used yardstick; the best criteria in any given case depends
upon the user’s purpose.
42
 Economic /Control Criteria
The economic /control definition cover:
a) Market share:- The characteristics of a small firm’s share of the market
is that it is not large enough to enable it to influence the prices of
national quantities of goods sold to any significant extent.
b) Independence:- Means that the owner has control of the business
himself.
c) Personalized management:- Is the most characteristics factor of all.
It implies that the owner activity participates in all aspects of the
managements of the business, and in all major decisions-making
processes. There is no delegation of authority.

All three of these characteristics must be satisfied if the business is to

43
rank as a small business.
 Role/Importance of MSEs in Developing
Countries
1) Large Employment Opportunities: MSEs are generally labor-
intensive. For every fixed amount of investment, MSE sector
provides employment for more persons as against few persons in
the large scale sector. Thus in a country like Ethiopia where capital
is scarce and labor is abundant, MSEs are especially important.
2) Economical Use of Capital: MSEs need relatively small amount
of capital. Hence it is suitable to a country like Ethiopia where
capital is deficient.
3) Balanced Regional Development/ Removing Regional
Imbalance/: Generally small enterprises are located in village and
small towns. Therefore it is possible to have a balanced regional
growth of industries. Ethiopia is a land of villages

44
 Setting up Small Scale Business
It is extremely important to take utmost care in identifying the product or service to be launched by the
entrepreneur; otherwise it might prove to be a costly mistake

45
 SWOT Analysis
Strengths are positive internal factors that contribute to an individual’s
ability to accomplish his/her mission, goals and objectives. Weaknesses
are negative internal factors that inhibit an individual’s ability to
accomplish his/her mission, goals and objectives. An entrepreneur
should try to magnify his strengths and overcome or compensate for
his/her weaknesses.
Opportunities are positive external options that an individual could
exploit to accomplish his/her mission, goals and objectives. Threats are
negative external forces that hinder an individual from accomplishing
his/her mission, goals and objectives.

46
 SWOT Analysis
These could arise due to competition, change in government policy,
economic recession, technological advances etc. Threats in the
environment can arise from competition, technological breakthroughs,
change in government policies etc. S/he might possess certain unique
skills or abilities, which along with his/ her knowledge and experience
can provide him/ her cutting edge.
An analysis of the above can give the entrepreneur a more realistic
perspective of the business, pointing out foundations on which s/he can
build future strengths and remove obstacles. The hierarchical approach
to the development of business idea is given below.

47
 Generally, a small business
Owner is usually the manager
Operates in one or very few locations
Typically serves a small market
Not dominant in its field

Why are small business important to economy?

They make exceptional contributions as they provide
a. New jobs as populations and economy grow, small business provide
new job opportunity.
b. Introducing innovations-many scientific breakthrough originated with
small organization. Photocopies, etc
c. Stimulating Economic competitions.
48
 Reasons for the more rapid growth of small firms in most developed
countries.

1. New technologies, such as numerically controlled machine tools, may

permit efficient production on a smaller scale
2. Greater flexibility is required as a result of increased global
competitions
3. Consumers may be coming to prefer personalized products over mass
produced goods.
 Discussion
what about in developing countries like Ethiopia?

49
 SMALL BUSINESS competitive
ADVANTAGES
 Meeting customer needs
 They often serve customers where the number of products and
services needed is small or the requirements are too specialized for
large businesses to make a profit.
 They can compete by paying attention to their customers.
 They get direct information from customers about likes or dislikes /
wants and needs
 Providing unique services
 They spend time determining needs and discussing alternatives.

SLIDE 50
Checkpoint 
 How can small businesses compete successfully with
larger businesses?
 Smaller businesses are able to provide more personalized
products and services to their customers.
 They are able to provide products and services where
smaller orders and projects are required and tend to fill
unique customer needs, which larger companies do not
provide.

SLIDE 51
Eight reasons why many small businesses
fail.

52
 Small Business Success Factors

A. Conducive Environment
1. Political Climate: - The overall political climate in a country is
important for the small scale entrepreneur to consider.
2. The Economic Environment: - An analysis of the economic
environment is particularly helpful in investment decision, market
measurement and in forecasting.
3. Technology: -Technological advances in the environment create
new needs for the small entrepreneur as far as adaptation and
adjustment is concerned.
4. Socio-Cultural Environment: - Finally, the socio-cultural
environment also creates a very important climate for the survival
of the enterprise
53
 Small Business Success Factors

B. Adequate Credit Assistance

C. Markets and Marketing Support

54
 Classification of Enterprises in Ethiopian
Context
1. In Case of Manufacturing Enterprise (Manufacturing,
Construction and Mining):
a) 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.
b) 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.

55
 Classification of Enterprises in Ethiopian
Context
1. In Case of Service Enterprise (Retailing, Transport, Hotel
and Tourism, ICT and Maintenance):
a) 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.
b) b) 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.

56
 Strength and weakness of small business

Strength
1. Independence
Most small business owners enjoy being their own boss, they like
the freedom to do things than way.
2. Financial opportunities
Many small business owners make more money running their own
company than they would be working for someone else.
3. Community services
if the person has reason to believe the public will pay for such
output, he/she will start a company to provide it.

57
 4. Job security
when one owns a business, job security is ensured.
5. Family employment (benefits)
create the employment in the family
higher moral and trust occur in family-run business
6. Challenge.
They want to win or lose on their own abilities the challenge
gives them psychological satisfaction

58
 Weaknesses
1. Sales fluctuations
in some months sales are very high, while in other they drop off
dramatically. The individual must balance cash inflows with cash
outflows.

2. Competition- Owning a business is the risk of competition (eg.

Restaurants)

3. Increased responsibilities- owner is often a bookkeeper,

accountant sales person, personnel manager.

4. Financial loses- when the owner makes all major decisions

6. Risk of failure- the ultimate risk the small business owner manger
59 faces is failure.
 Revision on Ch-3
Business Formation
 Forms of Business (a short explanation)
 Ways of going into business
 Definition and Importance of SMEs
 Setting up small scale business
 Roles of SMEs
 Business failure and success factors.
 Problems of small scale business in
Ethiopia