CHAPTER 3: Setting up a Small

Business Enterprise
Objectives
 After studying this unit, you will be able to:
Describe the steps for starting a small business
Explain the concept of enterprise location
Discuss the selection of type of organization
INTRODUCTION
This unit will help you to understand the procedure of
starting up a small business. The various sections and sub-
sections of this unit will also summarize how to select the
type of organization for startup of small business. Planning
is the first and the most crucial step for setting up a
business or venture.
Steps for Starting a Small Enterprise
Following are the various assumptions in this context:
 There is an uneven distribution of natural resources on the
plain. Raw materials are concentrated in specific sites.
 The size and location of markets are given at fixed points on
the plain.
 There are fixed locations of labor where wage rates are fixed
and labor is immobile and unlimited (capitalists love that).
 The area has a uniform culture, climate and political system.
 Entrepreneurs minimize costs of production.
 Perfect competition exists.
 Costs of land, structures, equipment and capital do not vary
regionally.
 There is a uniform system of transport over a flat surface.
Steps in Enterprise Location:
1. Selection of the region
2. Selection of the locality or community
3. Selection of the exact site, and
4. Selection of an optimum site
Steps for starting a small enterprise:
1. Analyse yourself and your objectives
2. Date with yourself for newer ideas
3. Consult publications and agencies
4. Date with yourself for a decision
5. Choose a line
6. Decide on form of ownership (sole
proprietary/partnership/cooperative/company (private/public))
7. Decide whether to purchase a going concern or to start a new
one.
Selection of the Type of Organisation
There are a number of organizations that a new
entrepreneur may select to meet his requirements,
ambitions, tastes and designs. He may go for (1) Sole
proprietorship, (2) Joint partnership, (3) Corporation.
1. Selecting a Business Entity: Sole Proprietorship

A sole proprietorship is both the simplest and the most

prevalent form of business organization. An important reason for
this is that it is the least regulated of all types of business structures.
Technically, the sole proprietorship is the traditional unincorporated
one-person business. For legal and tax purposes, the business is
the owner. It has no existence outside the owner. The liabilities of
the business are personal to the owner and the business ends when
the owner dies. On the other hand, all of the profits are also
personal to the owner and the sole owner has full control of the
business.
Advantages

Following are the advantages of sole proprietorship form of business:

1. Total Control of the Owner: The most appealing advantage of the sole proprietorship as
a business structure is the total control the owner has over the business. Subject only to
economic considerations and certain legal restrictions, there is total freedom to operate
the business however one chooses. Many people feel that this factor alone is enough to
overcome the inherent disadvantages in this form of business.

2. Simplicity of Organisation: Related to this is the simplicity of organization of the sole

proprietorship. Other than maintenance of sufficient records for tax purposes, there are no
legal requirements on how the business is operated.
3. Least Regulated of all Business: As was mentioned earlier, the sole proprietorship is the
least regulated of all businesses.

4. Registration with Local Bodies: Finally, it may be necessary to register with local, state,
and federal tax bodies for I.D. numbers and for the purpose of collection of sales and other
taxes. Other than these few simple registrations, from a legal standpoint little else is required to
start up a business as a sole proprietorship.

5. Various Tax Benefits: A final and important advantage to the sole proprietorship is the
various tax benefits available to an individual. The losses or profits of the sole proprietorship are
considered personal to the owner. The losses are directly deductible against any other income
the owner may have and the profits are taxed only once at the marginal rate of the owner. In
many instances, this may have distinct advantages over the method by which partnerships are
taxed or the double taxation of corporations, particularly in the early stages of the business.
Disadvantages
Following are the disadvantages of sole proprietorship form of business:

1. Risk to the Assets of Sole Owner: Perhaps the most important factor to consider before
choosing this type of business structure is that all of the personal and business assets of the
sole owner are at risk in the sole proprietorship.
2. Potential Difficulty in Obtaining Loans: A second major disadvantage to the sole
proprietorship as a form of business structure is the potential difficulty in obtaining
business loans.
3. Lack of Continuity: A further disadvantage to a sole proprietorship is the lack of continuity
that is inherent in the business form. If the owner dies, the business ceases to exist. Of
course, the assets and liabilities of the business will pass to the heirs of the owner, but the
expertise and knowledge of how the business was successfully carried on will often die
with the owner. Small sole proprietorships are seldom carried on profitably after the
death of the owner.
2. Selecting a Business Entity: Joint Partnership

A partnership is a relationship existing between two or

more persons who join together to carry on a trade or
business. Each partner contributes money, property, labor,
and/or skill to the partnership and, in return, expects to
share in the profits or losses of the business. A partnership
is usually based on apartnership agreement of some type,
although the agreement need not be a formal document.
Advantages
Following are the advantages of joint partnership form of business:
1. Greater Opportunity for Business: A partnership, by virtue of combining the
credit potential of the various partners, has an inherently greater opportunity for
business credit than is generally available to a sole proprietorship.
2. Tax Advantages: As with the sole proprietorship, there may be certain tax
advantages to operation of a business as a partnership, as opposed to a
corporation. The profits generated by a partnership may be distributed directly
to the partners without incurring any double tax liability, as is the case with the
distribution of corporate profits in the form of dividends to the shareholders.
Income from a partnership is taxed at personal income tax rates. Note,
however, that depending on the individual tax situation of each partner, this
aspect could
prove to be a disadvantage.
3. A Simple Form of Business: For a business in which two or more people
desire to share in the work and in the profits, a partnership is often the structure
chosen. It is, potentially, a much simpler form of business organization than the
corporate form. Less start-up costs are necessary and there is limited regulation
of partnerships.
Disadvantages
Following are the disadvantages of joint partnership form of business:
1. Potential for Conflict between Partners: The disadvantages of the
partnership form of business begin with the potential for conflict between
partners. Of all forms of business organization, the partnership has spawned
more disagreements than any other. This is generally traceable to the lack of a
decisive initial partnership agreement that clearly outlines the rights and duties
of the partners.
2. Unlimited Personal Liability: A further disadvantage to the partnership
structure is that each partner is subject to unlimited personal liability for the
debts of the partnership.
3. Legal Liability: Related to the business risks of personal financial liability is
the potential personal legal liability for the negligence of another partner. In
addition, each partner may even be liable for the negligence of an employee of
the partnership if such negligence takes place during the usual course of
business of the partnership. Again, the attendant risks are broadened by the
potential for liability based on the acts of other persons. Of course, general
liability insurance can counteract this drawback to some extent to protect the
personal and partnership assets of each partner.
4. Lack of Continuity: Again, as with the sole proprietorship, the partnership
lacks the advantage of continuity. A partnership is usually automatically
terminated upon the death of any partner. A final accounting and a division of
assets and liabilities is generally necessary in such an instance unless specific
methods under which the partnership may be continued have been outlined in
the partnership agreement.
 Selecting a Business Entity: Limited
Liability Company (LLC)
The limited liability company is a hybrid type of business
structure. It contains elements of both a traditional
partnership and a corporation. The limited liability company
form of business structure is relatively new.
Advantages

The members/owners in such a business enjoy a limited liability, similar to

that of a shareholder in a corporation. In general, their risk is limited to the
amount of their investment in the limited liability company. Since none of the
members will have personal liability and may not necessarily be required to
personally perform any tasks of management, it is easier to attract investors to
the limited liability company form of business than to a traditional partnership.
The members will share in the potential profits and in the tax deductions of the
limited liability company, but in fewer of the financial risks involved. Since the
limited liability company is generally taxed as a partnership, the profits and
losses of the company pass directly to each member and are taxed only at the
individual level.
 A further advantage of this type of business structure is that it offers a
relatively flexible management structure. A final advantage is that limited liability
companies are allowed more flexibility than corporations in how profits and
losses are actually allocated to the members/owners.
Disadvantages
In as much as the business form is still similar to a partnership in operation,
there is still a potential for conflict among the members/owners of a limited
liability company. Limited liability companies are formed according to individual
state law, generally by filing formal Articles of Organization of a Limited Liability
Company with the proper state authorities in the state of formation. Limited
liability companies are, generally, a more complex form of business operation
than either the sole proprietorship or the standard partnership. They are subject
to more paperwork requirements than a simple partnership but somewhat less
than a corporation. Limited liability companies are to far more state regulations
regarding both their formation and their operation than either a sole
proprietorship or a partnership.
 Selecting a Business Entity: Corporations
A corporation is a creation of law. It is governed by the laws of the state
where it was incorporated and of the state or states in which it does business.
In recent years it has become the business structure of choice for many small
businesses. Corporations are generally, a more complex form of business
operation than either a sole proprietorship or partnership. Corporations are also
subject to far more state regulations regarding both their formation and
operation. The following discussion is provided in order to allow the potential
business owner an understanding of this type of business operation.
 C-Corporation: In its simplest form, the corporate organizational structure
consists of the following levels:

1. Shareholders: who own shares of the business but do not contribute to the
direct management of the corporation, other than by electing the directors of the
corporation and voting on major corporate issues.
2. Directors: who may be shareholders, but as directors do not own any of the
business. They are responsible, jointly as members of the board of directors of
the corporation, for making the major business decisions of the corporation,
including appointing the officers of the corporation.
3. Officers: who may be shareholders and/or directors, but, as officers, do not
own any of the business. Officers (generally the president, vice president,
secretary, and treasurer) are responsible for day-to-day operation of the
corporate business.
Advantages
Following are the various advantages of corporation form of business:
1. One of the most important advantages to the corporate form of business
structure is the potential limited liability of the founders of and investors in the
corporation.
2. A corporation can have a perpetual existence. Theoretically, a corporation
can last forever. This may be a great advantage if there are potential future
changes in ownership of the business in the offing. Changes that would cause a
partnership to be dissolved or terminated will often not affect the corporation.
3. Unlike a partnership, in which no one may become a partner without the
consent of the other partners, a shareholder of corporate stock may freely sell,
trade, or give away his or her stock unless this right is formally restricted by
reasonable corporate decisions. The new owner of such stock is then a new
owner of the business in the proportionate share of stock obtained.
Disadvantages
Following are the various disadvantages of corporation form of business:
1. Loss of Individual Control: Due to the nature of the organizational structure
in a corporation, a certain degree of individual control is necessarily lost by
incorporation. The officers, as appointees of the board of directors, are
answerable to the board of management decisions.
2. Technical Formalities: The technical formalities of corporation formation
and operation must be strictly observed in order for a business to reap the
benefits of corporate existence. Corporate meetings, both at the shareholder
and director levels, are more formal and more frequent. In addition, the actual
formation of the corporation is more expensive than the formation of either a
sole proprietorship or partnership.
THANK YOU!!!