Business Formation Principles

Business Formation

• Three basic legal forms of business exist: Proprietorship, Partnership, and Corporation.

Proprietorship

• A business with a single owner.
• Owner has unlimited liability.
• Owner controls all decisions.
• Owner receives all profits.

Sole Proprietorship Features

• Single ownership
• One-person control
• Undivided risk
• Unlimited liability
• No separate business entity
• Less government regulation

Sole Proprietorship Advantages

• Simplicity
• Quick decisions
• High secrecy
• Direct motivation
• Personal touch
• Flexibility

Sole Proprietorship Disadvantages

• Limited funds
• Limited skills
• Unlimited liability
• Uncertain life
• Less synergy

Partnership

• Owned by two or more individuals with unlimited liability.
• Individuals pool resources to own the business.
• An agreement to carry on lawful business jointly and share profits arising from it.
• Individuals entering into the agreement are called partners.

Partnership Characteristics

• Association of two or more persons.
• Contractual relationship.
• Existence of a lawful business.
• Sharing of profit and loss.
• Mutual agency among partners.
• No separate legal entity of the firm.

Corporation

• A separate legal entity run by stockholders.
• Stockholders have limited liability.
• A separate legal personality distinct from owners.

Corporation Characteristics

• Unlimited liability
• Restriction on interest transfer
• Utmost good faith
• Continuity unaffected by debt or stock transfer
• Income tax on corporate profit and dividend
• Professional management distinct from shareholders.

Cooperatives

• An association of people with a common bond of interest.
• Voluntarily join to achieve a lawful common social or economic end.
• Making equitable contributions to required capital.
• Accepting a fair share of undertaking risks and benefits (aligned with cooperation principles).

Cooperatives Characteristics

• Open and voluntary membership
• Democratic control
• Limited interest on capital
• Division of net surplus
• Cooperative education

Concept of Small Business

• No universally accepted definition of small business.
• Varies according to country, institution, development level, and time.
• Small businesses are catalysts for economic growth in both developed and developing countries.

Small Business Owners vs. Entrepreneurial Venture

• Entrepreneurial venture is a growth-oriented innovative company with new product or service offerings to the market.

Definition of SMEs

• Two approaches to define small businesses:
  • Size criteria (number of employs and start-up capital, quantifiable).
  • Economic/control criteria (market share, independence, and personalized management, qualitative).

Size Criteria

• Size refers to the scale of operation and can be measured in several ways:
  • Number of employees (often used <50).
  • Total capital investment (e.g., plant, machinery).
  • Volume/value of sales turnover, asset size.
  • Volume/value of production
  • A combination of the stated factors.

Small Business Administration (SBA)

• Financing for the business is largely supplied by one individual or a small group.
• Usually fewer than 15-20 owners.
• Operations are often geographically localized, except for marketing functions.
• Compared to the largest firms in the industry, the business is small.
• The number of employees is usually fewer than 100.

Size Criteria by Country

• Size criteria varies from country to country. Specific numbers for employees and investment figures are provided for countries like Australia, Germany, France, China, Indonesia, and Malaysia.

Ethiopia's Definition of Micro and Small Enterprises

• Using capital as a size criteria, the Ethiopian Ministry of Trade has defined Micro and Small enterprises as follows:
• Microenterprise: Business enterprises in the Ethiopian economy with a paid-up capital (fixed assets) of not more than Birr 20,000 (excluding high-tech firms).

Small Enterprises in Ethiopia

• Business enterprises with a paid-up capital of at least Birr 20,000 but not more than 500,000 (excluding high-tech firms).

Economic/Control Criteria

• Market share: not large, doesn't influence the price of goods.
• Independence: the owner has control of the business themself.
• Personalized Management: It is a characteristic factor, with owners being actively involved in all business aspects, having legitimate decision-making power, but with little delegation of authority.
• Technology: labor intensive.
• Geographic area of operation: often local.

Setting Up Small Scale Business

• Setting up a new venture is challenging but rewarding.
• Identify four to five product/service ideas.
• Conducting a feasibility study.
• These steps increase the chance of success.

Stages for Setting up a New Venture

• Identifying Opportunities:
  • Discovering entrepreneurial potential.
  • Identifying a problem and a potential solution.
• Analyzing and Selecting the Opportunity (Opportunity Evaluation):
  • Evaluating the idea as a business opportunity
  • Investigating and gathering appropriate resources
• Launching and Developing the Enterprise (Implementation):
  • Forming the enterprise to create value
  • Implementing the entrepreneurial strategy
  • Planning the future

Approaches to Develop Business Ideas

• Environmental Analysis:
  • Entrepreneurship does not exist in a vacuum
  • The relationship between environment and entrepreneurship is two-way
  • Macro Environment (PESTLED): -Political Environment (stable/conducive climate, institutional support) -Economic Environment (liberalization) -Socio-Cultural Environment (customs, norms, traditions) -Technological Environment (new and effective technologies) -Legal Environment (simpler legal procedures)
    • Demographic Environment
  • Sectorial Analysis: Determining factors, such as, making the industry attractive (profits or high-growth rates). Includes history of the industry, future trends, new products and forecasts from the government/industry sector.
• SWOT Analysis: A tool that evaluates a business’s strengths and weaknesses, and external opportunities and threats.
• Product or Service: Using environmental opportunities with internal strengths (in terms of knowledge, skills, and experience) to launch a product or service. The proposed product/service must be compatible with the entrepreneur’s capabilities, available resources, and the overall needs of society.

Small Business Success and Failure Factors

• Success factors: -Conducive Environment (political, economic, technological, socio-cultural conditions) -Adequate Credit Assistance (low interest rates, flexible collateral requirements, lower equity ratios) -Markets and Marketing Support (market linkage)
• Failure factors: -Inadequate Management -Inadequate Financing -Negligence, fraud, disaster

Classification of Enterprises in Ethiopia

• Classification method based on sector, human power, and total asset.

Main Supporting Packages in Ethiopia

• Awareness creation about the sector
• Provision of legal services to form a legal entity
• Training
• Financial support with a mix of savings and loans from microfinance institutions (MFIs).
• Bookkeeping and audit services

Building a Successful Management Team

• Entrepreneurial Team: A group of two or more people interested in the venture's financial and other aspects, committed to its future and success; work is interdependent.
• Team Functions:
  • Execute the business plan.
  • Identify fundamental changes in the business.
  • Adjust the plan based on changes to maintain profitability.

Stages of Team Development

• Forming: Uncertainties about purpose, structure, and leadership.
• Storming: Intragroup conflict.
• Norming: Close relationships develop, demonstrating cohesiveness.
• Performing: Efficient and functional structure accepted by team members.
• Adjourning: Preparation for disbandment.

This quiz covers the fundamentals of business formation, focusing on the three primary legal structures: Proprietorship, Partnership, and Corporation. You'll explore the features, advantages, and disadvantages of sole proprietorships and partnerships, providing a comprehensive overview of business ownership options.