CHAPTER THREE

BUSINESS FORMATION

07/21/2024 SM Ch 1 -1
 3.3 Forms of Business organizations

There are three basic legal forms of businesses.

 Proprietorship
 Partnership and
 Corporation
3.4 Definition and Role/Importance of SMEs in
Developing Countries
3.4.1 Definition of MSEs
1. Size Criteria approaches
 Though the criteria used to measure the size
(scale of operation) of businesses vary.
 The most widely used yardsticks are;
 The number of employees
 Volume, and value of sales turnover
 Asset size, and volume of deposits
 Total capital investment
 Volume/value of production, and
 A combination of the stated factors
 Con’t…
 The general criteria are suggested by Small
Business Administration (SBA).
 Owned and financed by one individual or a small
group/ 15 or 20 owners in a rare case/.
 The firm’s operations are geographically
localized.
 The business is small Compared to the biggest
firms in the industry
 The number of employees in the business is
usually fewer than 100.
2. Economic/control criteria approach.
Covers four characteristics :
 Small market share: it is not large enough
and unable to influence the prices of
national quantities of goods sold to any
significant extent.
 Independence: ,the owner control the
business himself/herself.
 Personalized Management: little
delegation/ the owner actively participates
in all aspects of the management of the
business
 Limited geographical area of operation; The
3.4.2 Role/Importance of MSEs in Developing Countries
(Reading Assignment)

 Large Employment Opportunities:

 Balanced Regional Development/ Removing
Regional Imbalance
 Equitable Distribution of Wealth and
Decentralization of Economic Power
 Unregulated Growth of Large-scale
industries
 Dispersal over Wide Areas
 Higher Standard of Living
 Mobilization of Locals Resources/Symbols of
National Identity
 3.5 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. These can be further sub-divided into seven steps
as shown below:
 Environmental Analysis
 For an analysis of the environment of
entrepreneurship you would be required to
develop an understanding of macroeconomic
and industry/sector specific factors.
 Macro Environment
 Consists of the political, technological, social,
legal and economic environments.
 Sectoral Analysis
 Study the sector or industry conditions in
which the entrepreneur proposes to launch a
venture.
 con’t…
Macro
Environmental Analysis

Sectoral Analysis

SWOT Analysis

Product/Service

Fig 3.2 Hierarchical Environmental Analysis

 Causes of Business Failure

 The most common causes are inadequate

management and financing.
I. Inadequate Management;
• 89 % of failure of the businesses is
internal factors (controllable factors)
 Adequate capital
 Cash flow
 Facilities/equipment
 Inventory control
 Human resources
 Leadership
 Organizational structure
II.Inadequate Financing:
 Includes improper managerial control as
well as shortage of capital.
 You don’t have adequate funds to begin
with, you will not be able to afford the
facilities or personnel you need to start up
the business correctly.
 You do possess adequate capital but do not
manage your resources wisely, you may be
unable to maintain adequate inventory or
keep the balance needed to run the
business.
 Con’t…
 In General, There are various causes of
failure ;
 Extend too
 Much credit
 Fail to plan for the future
 Overinvest in fixed assets
 Hire the wrong people.
 Business Termination VS Failure

• A termination occurs when a business no

longer exists for reasons of getting
opportunity to sell for a profit, to move
on to a new business , to retire, or lost
interest in the business.
• If market for product have changed or
become saturated, owner decided it would
be more appealing to work for someone
else.
• A business failure occurs when a business
closes with a financial loss to a creditor.
Mistakes Leading to Business Failure
The most common mistakes are;
 Neglect to plan for the future
 Lack of commitment and hard work
 No delegation/ not hiring additional
employees
 Inaccurate estimates of cash flow and capital
requirements.
 3.6.2 Small Business Success Factors

• Identifying failure factors can discover

ways to tilt the scales towards success.
These success factors are categorized
as:-
i. Conducive Environment;
ii. Adequate Credit Assistance;
iii. Markets and Marketing Support.
i. Conducive Environment
 Political, economic, technological and
socio-cultural factors
ii. Adequate Credit Assistance
 Adequate and timely supply of credit
 Special financing programs such as lower interest
rates; less collateral requirements and lower
equity ratio;
 Various assistance schemes such as preparing the
project study; etc.
iii. Markets and Marketing Support
 Small enterprises can sell their products as one
body through closely-knit associations or
organizations.
 The government assist small groups of
entrepreneurs in selling their products.
Table 3.2. Improved definition of MSE

Level of Sector Human Power Total Asset

Enterprise

Industry ≤5 Br ≤100,000
Micro Enterprise
Service ≤5 Br ≤50,000

Small Enterprise Industry 6-30 Br ≤1,500,000

Service 6-30 Br ≤500,000

• Priority Sectors and Sub-Sectors for
MSEs Engagement In Ethiopia
 Manufacturing Sector
 Construction Sectors
 Trade Sectors
 Service Sectors
 Agriculture Sector (Urban Agriculture)
 3.8 Main Supporting Packages for MSEs Development in Ethiopia
(Reading Assignment)

In Ethiopia supporting packages for MSEs includes;

• 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);
• Facilitate working premises; industry extinction
services and BDS provision;
• Bookkeeping and audit services.
 3.9 Problems of Small Scale Business in Ethiopia

• Small-scale businesses have not been able to

contribute substantially to the economic
development, particularly because of financial,
production, and marketing problems.
• These problems are still major handicaps to
their development. Lack of adequate finance
and credit has always been a major problem of
the Ethiopian small business.

• Small-scale units do not have easy access to

the capital because they mostly organized on
proprietary and partnership basis and are of
very small size.
 Con’t…
• Small scale enterprises find it difficult to get
raw materials of good quality at reasonable
prices in the field of production.
• Furthermore, 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.
• How ever, Small business’s owner can avoid
some of the common by knowing the business in
depth; developing a solid business plan; managing
financial resources; understanding financial
statements; and learning to manage people
 3.10.2 Designing the Organization
The 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. These expectations are grouped
into five areas:-
• Organization structure
• Planning, measurement, and evaluation
schemes
• Rewards
• Selection criteria
• Training
 3.9.3 Building the Management Team and a Successful Organization Culture

There are some important issues to

address before assembling and building the
management team. In essence, the team
must be able to accomplish three
functions:-
 Execute the business plan;
 Identify fundamental changes in the business
as they occur; and
 Make adjustments to the plan based on
changes in the environment and market that
will maintain profitability.
 Con’t…
• Important considerations and strategies
in recruiting and assembling an effective
team and creating an effective and
positive organization culture.
1. The entrepreneur’s desired culture must
match the business strategy outlined in the
business plan.
2. The leader of the organization must create
a workplace where employees are motivated
and rewarded for good work.
3. The entrepreneur should be flexible enough
to try different things.
 Con’t…
4. It is necessary to spend extra time in the
hiring process.

5. The entrepreneur needs to understand the

significance of leadership in the
organization.

Generally, finding the most effective team

and creating a positive organization culture is
a challenge for the entrepreneur but is just as
critical as having an innovative, marketable
product. It is an important ingredient in an
organization’s success.