5.

0
BUSINESS FORMATION

CLO2:
Demonstrate the entrepreneurial mind in identifying
business opportunities.
5.0 Business Formation

Learning Outcome
At the end of the session, students should be able to:
1. Identify types of business formation
2. Explain advantages and disadvantages of business
formation
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BUSINESS FORMATION
There are four common methods of starting a
new venture:
1. Starting from Scratch
2. Buying an Existing Business
3. Family Business Succession
4. Acquiring a Franchise
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5.1 Starting From Scratch

The most popular method among start-up
entrepreneurs

Entrepreneur has to make decisions on:

a. Appropriate form of business
b. Business or trade name
c. Business and product/service image
d. Suitable location of the business
e. Appropriate funding to kick-start the business
f. Proper business planning for everything that
needs to be take into consideration.
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ADVANTAGES of Starting from

Scratch
a. Entrepreneurs are free to make his/her own
decisions.
b. Entrepreneurs have the opportunities to try and
practice his/her own ideas.
c. Entrepreneurs are free to choose suitable
business location and premise, and acquiring
appropriate machine and equipment for the
business.
d. Entrepreneurs are free to develop business
image and personality that suits their desire
and interest.
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DISADVANTAGES of Starting from

Scratch
a. Entrepreneurs need to put in a lot of efforts. It
requires more time, energy and money in
ensuring the business kick-off.
b. Higher chances of losses due to high project
implementation cost.
c. Entrepreneurs are not able to accurately
estimate sales, cost and profit ( zero business
history i.e. sales record, costing and so on).
d. A new venture usually has no track record.
Therefore, it is difficult for entrepreneurs to
convince the financial institutions in getting
the financing.
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5.2 Buying an Existing Business

 Entrepreneurs start a new venture buy taking over
an existing business either buying the whole
business or partial shares in the existing business.

 Entrepreneurs must “investigate” before buying.

Previous owners have reasons why they wanted to
sell their business. So, it is the entrepreneurs’
responsibilities to “investigate” the business that
they want to buy as well the “background” of the
existing owners
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ADVANTAGES of Buying an Existing

Business
a. The time entrepreneurs spent to start the
business is faster compared to starting a new
venture form scratch
b. The probability of getting the financing is
greater if the existing business has a good track
record.
c. Existing market and loyal customers of existing
business.
d. Established networking with suppliers,
supporting agencies and communities.
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DISADVANTAGES of Buying an
Existing Business
a. Buying existing business requires bigger amount
of capital either to buy the whole business or part
of the business.
b. If the existing business is not well managed by the
previous owner, entrepreneurs need to put in a
lot of efforts, money and time to improve the
situation.
c. Entrepreneurs have to respect and abide the
agreements that have been made by the
previous owner with related parties (i.e. suppliers,
agencies etc.)
d. Conflicts could arise between the new owner
and existing employees
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5.3 Family Business Succession

 Entrepreneuris the successor of the business
which was started by the earlier family
members (predecessors).

 Entrepreneur did not face the difficulties of

starting-up a new venture.
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Levels of Family Business

Generally, there are four levels of family business:

Level 1: Business Inception

(the founder)

Level 2: Business Growth & Development

(the founder & 1st generation)

Level 3: Business Maturity

(the founder,1st generation & 2nd generation)

Level 4: Business Transition Period

(1st generation, 2nd generation & 3rd generation)
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Challenges of Family Business

a. Financing – debt financing versus equity
financing
b. Liquidity/Cash – family’s need for cash versus
business’s needs for cash
c. Transition period – older generation versus new
generation (to let go or not to let go –
ownership & management power)
d. Succession - finding the right successor
(competent, motivated, and the most
important getting consensus from all family
members)
e. Emotion – family interest versus business interest
f. Rivalry – siblings, cousins
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ADVANTAGES of Family
Business
a. Freedom and flexibility in decision making.
b. Pride of family culture, high commitment and
motivation lead to business stability.
c. Family members willingness to “sacrifice” their
time and money (e.g. no salary taken for 1st year
of operation).
d. High possibility of achieving great monetary
success due to high commitment.
e. Family members have good exposure to business
environment.
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DISADVANTAGES of Family Business

a. Unstructured early-stage business organization.
b. Early-stage limited financial resources.
c. Family conflicts such as siblings and/or cousins
rivalry.
d. Nepotism among family members (e.g.
incompetent family member is given a better
management position).
e. Traditions practiced by older generation passed
on to new generation could lead to resistance
to change.
f. Difficulty in getting the right successor.
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5.4 Acquiring a Franchise

 Another alternative of starting a new business
 A franchise is a product and/or service distribution
system which is governed by a contract
 Made between two parties namely, the franchisor
and the franchisee
 The franchisor is a company which sells the right to
another party to operate the franchise.
 The franchisee is a person who purchases the right
from the franchisor to operate the franchise
 Operating a franchise includes selling and
marketing the products and/or services using the
trade name and trade mark, as well as a set of
systems developed and owned by the franchisor.
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Acquiring a Franchise
 The right to operate the franchise granted by the
franchisor to the franchisee involves a few payments
made by the franchisee agreed upon the signing of a
franchise. These fees are:
a) Franchise Fee – one-off payment made by the
franchisee to purchase the right to operate the
franchise
b) Royalty - an on-going payment made by the
franchisee to the franchisor based on the percentage
of sales as agreed upon the signing of franchise
contract (monthly or yearly)
c) Advertising and Promotional Contribution - an on-
going payment or contribution made by the
franchisee to franchisor’s advertising and promotional
fund.
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Types of Franchise Systems

Two major types of franchise system:

 Product/Trade name Franchise

 Business Format Franchise
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Product/Trade name Franchise

 This type of franchise system involves the

franchisee acquires sales right which includes
the trade name, trademark and/or products
from the franchisor upon the signing of the so-
called dealership contract and agreed to sell
the product line identified by the franchisor.
This type of franchise system is commonly
used in the automotive, petrol kiosk and
service station, soft beverages and tire
industries.
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Business Format Franchise

 This franchise system is also named “full-fledge
franchise”. The franchisee is granted the right
to manufacture and market the franchisor’s
product and/or services using a complete
franchisor’s business “set-up” which comprises
of intellectual properties (trade name. trade
mark, etc.); marketing strategies (pricing
structure guideline, promotional activities
etc.), guided operational activities
(franchisee is equipped with operation
manual and has to undergo a training),
premise settings and layout ( exterior and
interior layout; ambience, color scheme and
decoration must in-line with franchisor’s brand
and image).
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ADVANTAGES of Franchising
To the Franchisee:
a. Lower business risks as franchisee shares the business risks
with the franchisor.
b. Better market acceptance of products and/or services
offered as they are established products and/or services
of the franchisor.
c. Benefits of economies of scales
d. Guidance by the franchisor’s management team
e. Continuous support from the franchisor and government
agencies that involved in the development franchise
industry.
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ADVANTAGES of Franchising
To the Franchisor:
a. The franchisor’s business expansion can be done through
recruitment of new franchisees.
b. Benefits of economies of scales
c. Lower business risks as franchisor shares the business risks with
the franchisees.
d. Problems related human resource management is reduced
due to the fact that the franchisees have to manage the
human resource related matters themselves.
e. The franchisor can put more focus on product research and
development since business expansion is done through
franchise system.
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DISADVANTAGES of Franchising
To the Franchisee:
a. Limited freedom and flexibility to manage the
business according to franchisees’ desire
b. The franchise right granted by the franchisor has
its price to pay; the franchise fee, royalty and
advertising & promotional contribution
c. Limited product varieties; the franchisees are
allowed to market and sell only the franchisor’s
products
d. Fear of chain-reaction; bad reputation and
tarnished image due to the fault of either the
franchisor or the franchisee would affect the
whole franchise system
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DISADVANTAGES of Franchising
To the Franchisor:
a. Franchisee conformity; it is difficult to manage
the franchisees especially in ensuring the
conformity of the operational methods of all
franchisees in the system due to the fact that
they are not franchisor’s employees.
b. The franchisor/franchisee goal incompatibility;
The franchisor and franchisees may have
different business objectives as well as personal
objectives that could jeopardize the business
“marriage”.
c. “Wrong” franchisee; There are franchisees who
want an “easy-ride” in an attempt to gain instant
popularity for the business.
d. Competition through imitation of business
concept and model