CHAPTER THREE

BUSINESS FORMATION
 After studying this chapter, you should be
able to:

• Explain the Concept of Business Development;

• Identify the 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.
• What is small business and business
formulation.
 3.1 INTRODUCTION
3.2The Concept of Small Business Development

• 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
 Definition and Characteristics of Small
Business
• Small business: is the types of business
privately owned, and have Relatively
small number of and low capital of
income.
• There are two approaches to define small
business.
– Size criteria
– Economic/control criteria.
 Definition and Characteristics of Small
Business

• Size refers to the scale of operation

• Some of the major criteria used to measure
size are:
– number of employees (mostly used)
– volume, and value of sales turnover, asset size…
– total capital investment,
– volume/value of production,
 Definition and Characteristics of Small
Business
• Using capital as size criteria, Ministry of
Trade and Industry of Ethiopia adopted
official definition of Micro and Small
Enterprises as follows:
– Microenterprises are business enterprises found
in all sectors of the Ethiopian economy with a
paid-up capital (fixed assets) of not more than Birr
20,000  but excluding high-tech consultancy firms
and other high-tech establishments.
 Definition and Characteristics of Small
Business
• Using capital as size criteria, Ministry of
Trade and Industry of Ethiopia adopted
official definition of Micro and Small
Enterprises as follows:
– Microenterprises are business enterprises found
in all sectors of the Ethiopian economy with a
paid-up capital (fixed assets) of not more than Birr
20,000  but excluding high-tech consultancy firms
and other high-tech establishments.
 Definition and Characteristics of Small
Business
2. Economic/Control Criteria
• All of these characteristics must be satisfied if
the business is to rank as a small business.
– Market share
– Independence
– Personalized Management
– Technology
– Geographical area of operation
How can small businesses compete successfully with
larger businesses?
 Core Competencies of Small Business
Enterprise
• Good knowledge of the market – Due to
proximity
• Flexibility – Market Responsiveness
• Innovative capability
– In general smaller businesses are able to provide
more personalized products to their customers. They
are able to provide products where smaller orders and
projects are required and tend to fill unique customer
needs, which larger companies do not provide.
• What are different forms of
business??
 3.3 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:-
• Proprietorship,
• Partnership, and
• Corporation, with variations particularly in
partnerships and corporations.
Legal Forms of Business Description
Cont.
1) Proprietorship Form of business with single
owner who has unlimited ,
liability, controls all decisions,
and receives all profits.

2) Partnership Two or more individuals having

unlimited liability who have
pooled resources to own a
business

3) Corporation Separate legal entity that is run by

stockholders having limited
liability
What is Role/Importance of MSEs in
Developing Countries…..
 3.4 Role/Importance of MSEs in Developing
Countries…..

• Unregulated Growth of Large

• Dispersal over Wide Areas
• Higher Standard of Living
• Mobilization of Locals Resources/Symbols of
National Identity
• Innovative and Productive /Simple Technology
• Less Dependence on Foreign Capital/ Export
Promotion:
 Role of Small Business
in Economic Development……
1. Creating Jobs Producing
2. New Products
3. Serving Large Corporations
4. Providing Specialized Products
 Role/Importance of MSEs in Developing Countries…..

• Promotion of Self Employment

• Protection of Environment
• Shorter Gestation Period
• Facilitate Development of Large Scale
Enterprises
• Individual Tastes, Fashions, and
Personalized Services
• More Employment Creation Capacity
• what are steps Setting up Small Scale
Business??
3.5 Setting up Small Scale Business
• Steps for Setting up the Entrepreneurial
Venture
• The entrepreneurial process of launching a
new venture can be divided into three key
stages of: Discovery; Evaluation; and
Implementation. These can be further sub-
divided into seven steps as shown below
• Why some business are failed and
some business are succeed?? What
it would like in Ethiopian context
And what are the solution for those
problem,
 3.6 Small Business Failure and Success
Factors
3.6.1 Small Business Failure Factors
• What Is Business Failure?
• Dun & Bradstreet, a financial research firm, 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 from creditors).
 Small Business Failure factors
• According to Dun & Bradstreet (2004)finding, There are 12
broad causes that lead to a business failure:
• 1.Lack of Industry Experience
– Every business has an environment in which it operates.
• The internal resources of a firm must match the needs
of the environment to which the firm caters. Lack of
experience in the industry will lead to poor organization
of a firm and its resources.
• The structure of the industry in which the organization
operates substantially influences small firm
performance outcomes
 Small Business Failure factors
• 2.Inadequate Financing
– Many businesses fail due to lack of proper
financing channels. It is not a matter of
unavailability of funding, but the lack of planning
for funding to support opportunities for growth.
– Planning in advance, rather than looking for
financing just when needed, is a good practice.
Small Business Failure factors….
• 3.Poor Business Planning
– Nine out of ten business failures in the United States are caused by a lack of
general business management skills and planning.
– A good business plan helps identify the mission; cost structure; market;
external influences; and strengths and weakness of a business.

• 4.Management Incompetence
– Ninety percept of business failures are associated with "management
inadequacy", which consist of either management inexperience or
incompetence.
– Good management efficiently implements and monitors the strategic and
operational plan of a business.
– A good strategic plan is only good as the management's ability to implement
changes in day to day operations
Small Business Failure factors….
• 5.Ignoring Competition
– Capitalism is a cutthroat system. Customers are
always looking for the best deal, or at least, a
better deal.
– And if the competition offers better products,
services, or prices, the customers will succeed at
the expense of the business.
– Keeping an eye on competitors and positioning the
products accordingly is vital to staying in business.
Small Business Failure factors….
• 6.Unworkable Goals
– It is one thing to set goals and another thing to set
workable goals.
– Entrepreneurial initiatives are fundamentally
influenced by uncertainty.
– Setting realistic goals, within the bounds of
acceptable risk taking and optimism, is important.
Small Business Failure factors….
• 7.Diminished Customer Base
– Competition can cause the customer base to diminish.
From a small business's perspective, it is good to focus
on a customer strategy that works well for their business.
– At the same time it is also dangerous to focus only on
one recipe for success.
– Diversifying the customer base is an important factor in
building the business.
– Being flexible enough to adapt to new trends and ideas is
important to staying in business.
Small Business Failure factors….
• 8.Uncontrolled Growth
– Uncontrolled growth of the business can also cause it
to fail if not handled appropriately.
– Obesity is a problem in business as it is in an
individual's health.
– Proper planning must be in place even for business
growth.
– Successful growth requires a professional
management team, flexible organization, and proper
systems and controls.
Small Business Failure factors….
• 9.Inappropriate Location
– The old real estate maxim - location, location,
location - may be even truer in the small business
world.
– Even the best-run retail establishment will have a
difficult time succeeding if it is in a poor location.
– Location may not be applicable to all types of
businesses, but when it is, it may be critically
important.
Small Business Failure factors….
• 9.Inappropriate Location
– The old real estate maxim - location, location,
location - may be even truer in the small business
world.
– Even the best-run retail establishment will have a
difficult time succeeding if it is in a poor location.
– Location may not be applicable to all types of
businesses, but when it is, it may be critically
important.
 Small Business Failure factors
• 10.Poor Systems of Control
– While setting proper goals to manage the business, a system of
controls is also needed to measure performance.
– Checks and metrics help owners manage organizational activities.
– A firm cannot control the external factors affecting its
environment such as customers
– and competitors but it can adapt its internal organizational
activities.
– A lack of proper control on internal activities can eventually
lead to business failure. Controls can be implemented in
several aspects of the business.
 Small Business Failure factors
• 11.Lack of Entrepreneurial Skills
– Mostly during the start up phase of a new business, lack of
entrepreneurial skills in an owner can cause a business to
fail.
– This may not be true during the later growth and maturity
periods of business where more administrative and
management skills are required.
– A small firm's performance outcome is a function of many
variables, including individual owner characteristics, owner
behaviours, and environmental influences.
– Entrepreneurs generally have a high need for achievement
and social awareness, and they are high risk takers.
– Consequently, the personal and personality characteristics
 Small Business Failure factors
(in the other way of looking)
• 1.Poor operations management – The manager
lacks the ability to operate a small business.
• 2.Lack of experience – Many owners start businesses
in industries in which they have no experience
• 3.Poor financial management – Many owners start
with too little money and with little or no
understanding of financial spreadsheet applications.
Illegal loan too!
• 4.Over-investing in fixed assets – Owners who over-
invest in fixed assets may find themselves with no
access to funds for working capital.
Problems in Ethiopian small Business
• Small-scale businesses have not been able to
contribute substantially to the economic development,
particularly because of:
– financial,
– production, and
– marketing problems

Lack of adequate finance and credit has always been

a major problem of the Ethiopian small business.
 Overcoming Obstacles
• Small business owner can avoid some of the
common pitfalls that lead to business failure
by:
1. Knowing the business in depth
2. Developing a solid business plan
3. Managing financial resources
4. Understanding financial statements
5. Learning to manage people effectively…
 3.7.2 Small Business Success Factors

These success factors are categorized as:-

– Conducive Environment;
– Adequate Credit Assistance;
– Markets and Marketing Support.
Thank You