Review Chapter 3: Business Formation

• Definition the Concept of Business Development

• Identify the Forms of Business and Ownership
• Analyze the Importance/Role of MSEs in Ethiopia/ Intl
• Set Up Small Scale Business
• Distinguish the Failure and Success Factors of MSEs
• Identify the Problems of Small Scale Business in Ethiopia
• Develop Organizational Culture
 1. Business Formation
• Business formation refers to the process of legally establishing a new business
entity.
• It involves selecting a business structure, registering the business with the
appropriate government authorities, and fulfilling other legal requirements
necessary to operate the business
• 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
 2. The Concept of Small Business Development

• Specifying size and standard to define small business is necessarily

arbitrary, because people adopt different standards for different purposes.
• Based on socio- economic conditions, countries define small business
differently.
• But all may use size and economic criteria as a base to define small
business.
• Size criteria include number of employees and the startup capital. Size
does not always reflect the true nature of an enterprise;
• in addition, qualitative characteristics are used to differentiate small
business from other business with the offerings.
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• The economic/control definition covers market share, independence and
personalized management.
• Micro and small enterprises (MSEs) cover a wider spectrum of industries and
play an important role in both developed and developing economies.
• Ethiopia is no exception and MSEs occupy a prominent position in the
development of the Ethiopian economy.
• While the small entrepreneurs can set up a unit even with less capital, enjoy
quick returns and have the flexibility to handle the vagaries(change) of the
market, they have to face many problems like lack of finance, poor operations
management, lack of experience, poor financial management, etc,.
• The process of setting up a venture begins with searching for an opportunity.
• Identifying a good opportunity is a difficult task and involves scanning the
environment and the use of creativity and innovation
 3. Forms of Business (Legal Forms)
• There are three basic legal forms of business formation with some variations available
depending on the entrepreneurs’ needs.
• These three basic legal forms are compared with regard to ownership, liability, start-up
costs, continuity, transferability of interest, capital requirements, management control,
distribution of profits, and attractiveness for raising capital.
• It is very important that the entrepreneur carefully evaluate the pros and cons of the
various legal forms of organizing the new venture.
• This decision should be made before the submission of a business plan and request for
venture capital.
• The three basic legal forms are: Proprietorship, Partnership, and Corporation
• Proprietorship = Form of business with single owner who has unlimited liability, controls
all decisions, and receives all profits.
• Partnership = Two or more individuals having unlimited liability who have pooled
resources to own a business
• Corporation = Separate legal entity that is run by stockholders having limited liability
 4. Definition and Role/Importance of MSEs in Developing Countries
• Small businesses are playing an important role in the industrial economy of the world.
• These are particularly important in the developing economies.
• Small business is predominant even in developed countries such as USA, Japan etc.
• There is a difference between small business owners and entrepreneurial ventures as
well
• An entrepreneurial venture often is a growth-oriented innovative company with
product or service offerings that are new to the market.
• Small businesses could be entrepreneurial ventures. Most entrepreneurial ventures
start as a small business.
• However, some discernible characteristics still differ them.
• Most small businesses’ owners work with known products and services aimed at
incremental growth, and their innovation is focused on sales, marketing, and market
expansion
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• Entrepreneurial ventures incorporate a different set of strategies. These entities are aimed at rapid
growth and apply innovation and creativity at every node of the business process.
• They work with new offerings, and they face a lot more uncertainties; hence, their strategy calls
for continuous work on mitigating uncertainty and risk reduction.
• Specifying size and standard to define small business is necessary because people adopt different
standards for different purposes.
• For example, legislators may exclude small firms from certain regulations and specify ten
employees as the cut-off point.
• Moreover, a business may be described as “small” when compared to larger firms, but “large”
when compared to smaller ones.
• For example, most people would classify independently owned gasoline stations, neighborhood
restaurants, and locally owned retail stores as small business.
• Similarly, most would agree that the major automobile manufacturers are big businesses.
• And firms of in-between sizes would be classified as medium on the basis of individual
viewpoints
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• There are two approaches to define small business.
• They are: Size Criteria, and Economic/control criteria.
1. Size Criteria
• Even the criteria used to measure the size of businesses vary; size refers to the scale
of operation. Some criteria are applicable to all industrial areas, while others are
relevant only to certain types of business.
• For instance, some of the criteria used to measure size are: 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.
• Even though the number of employees-is the most widely used yardstick, the best
criterion in any given case depends upon the user’s purpose.
• To provide a clearer image of the small firms, the following general criteria for
defining a small business are suggested by Small Business Administration (SBA).
• Financing of the business is supplied by one individual or a small group. Only in a
rare case would the business have more than 15 or 20 owners.
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• Except for its marketing function, the firm’s operations are geographically
localized.
• Compared to the biggest firms in the industry, the business is small.
• The number of employees in the business is usually fewer than 100.
• This size criteria based definition of MSEs varies from country to country.
• All over the world, number of employees or capital investment or both has
been used as the basis for defining MSEs.
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2. Economic/Control Criteria.
• Size does not always reflect the true nature of an enterprise. In addition,
qualitative characteristics may be used to differentiate small business from
other business. The economic/control definition covers:
• Market Share,
• Independence, and
• Personalized Management.
• Geographical Area of Operation.
• All four of these characteristics must be satisfied if the business is to rank
as a small business.
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I) Market Share: - The characteristic of a small firm’s share of the market is that it is not large enough
to enable it to influence the prices of national quantities of goods sold to any significant extent.
II) Independence: Independence means that the owner has control of the business himself/herself.
• It, therefore, rules out those small subsidiaries which though in many ways fairly autonomous,
nevertheless have to refer to major decisions (e.g., on capital investment) to a higher level of
authority.
III) Personalized Management: It is the most characteristics factor of all. It implies that the owner
actively participates in all aspects of the management of the business, and in all major decision-
making process. There is little delegation of authority and one person is involved when anything
material is involved.
IV) Technology: Small business is generally labor intensive and only few are technology intensive.
V) Geographical Area of Operation: The area of operation of a small firm is often local.
• Generally, small business is a business that is privately owned and operated, with a small number of
employees and relatively low volume of sales
 Role/Importance of MSEs in Developing Countries (MSEs)

• cover a wider spectrum of industries and play an important role in both developed and
developing economies.
• Ethiopia is no exception and MSEs occupy a prominent position in the development of the
Ethiopian economy.
• Over the years, the number of MSEs is growing from time to time and they need a strong
support on Scio- economic and political ground.
• Some of the contributions are hereunder
1) Large Employment Opportunities: MSEs are generally labor-intensive. For every fixed
amount of investment, MSE sector provides employment for more persons as against few
persons in the large scale sector. Thus in a country like Ethiopia where capital is scarce and
labor is abundant, MSEs are especially important.
2) Economical Use of Capital: MSEs need relatively small amount of capital. Hence it is
suitable to a country like Ethiopia where capital is deficient.
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3) Balanced Regional Development/ Removing Regional Imbalance/:

• Generally small enterprises are located in village and small towns.
• Therefore it is possible to have a balanced regional growth of industries.
• Ethiopia is a land of villages. Another problem is the continuous shifting of people from
rural to urban areas which causes over-crowding in cities with slum conditions due to lack
of social and medical amenities which require heavy investments.
• This problem can be solved by inducing people to set up micro and small firms in rural
areas. Large scale industries have the tendency to concentrate in big cities.
• As a result, semi urban and rural areas remain deprived of the benefits of industrialization.
• Moreover, undue concentration of large industries in urban areas creates several problems,
e.g., pollution, shortage of civic facilities, etc.
• Due to lack of employment opportunities in the country side, people migrate in large
numbers to big cities. Micro and small-scale units can be located in rural and semi urban
areas to reduce regional disparities
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4) Equitable Distribution of Wealth and Decentralization of Economic Power:
It removes the drawbacks of capitalism, abnormal profiteering, concentration of wealth and
economic power in the hands of few etc.
5) Unregulated Growth of Large-scale industries results in concentration of economic·
• power in the hands of a few; and consequently, gross inequalities in the distribution of income
and wealth will occur.
• On the other hand; income generated in a large number of small enterprises is dispersed more
widely and its benefit is derived by the large segments of the society
• This is due to wide spread ownership and decentralized location of small scale enterprises.
• In this way, small & medium scale enterprises bring about greater equality of income
distribution. It is also argued that most of the micro and small scale units are either proprietary
or partnership concerns.
• As a result, relations between workers and employers are more harmonious in micro and small
enterprises than in large enterprises. Micro and small enterprises also encourage competitive
spirit and generate the impetus to self-development.
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6) Dispersal over Wide Areas- MSEs has a tendency to disperse over wider areas and they
play a key role in the industrialization of a developing country.
7) Higher Standard of Living: MSEs bring higher national income, higher purchasing
power of people in rural and semi-urban areas.
8) Mobilization of Locals Resources/Symbols of National Identity: The spreading of
industries even in small towns and villages would encourage the habit of thrift and
investment among the people of rural areas. Small scale businesses are locally owned and
controlled, and can strengthen family and other social systems and cultural traditions. They
are perceived as valuable in their own right as well as symbols of national identity.
9) Innovative and Productive /Simple Technology: New but simple techniques of
production can be adopted more easily by MSEs without much investment. Small
businesses are highly innovative though they do not maintain their own research and
development.
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10) Less Dependence on Foreign Capital/ Export Promotion:
• MSEs use relatively low proportion of imported equipment and materials. The machinery needed for
these industries can be manufactured within the country. Micro and small scale enterprises are opening up
fresh avenues in the export market in our world.
• Realizing the importance of the small and medium- scale sectors in the economy; the Ethiopian
government has adopted several measures to speed up the growth of micro and small size enterprises.
11) Promotion of Self Employment: MSEs foster individual skill and initiative and promote self
employment particularly among the educated and professional class.
12) Protection of Environment: MSEs help to protect the environment by reducing the problem of pollution.
13) Shorter Gestation Period: In these enterprises the time-lag between the execution of the investment
project and the start of flow of consumable goods is relatively short.
14) Facilitate Development of Large Scale Enterprises: MSEs support the development of large enterprises
by meeting their requirements of inputs of raw materials, intermediate
• goods, spare parts etc. and by utilizing their output for further production.
.
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15) Individual Tastes, Fashions, and Personalized Services:

• Small businesses have the flexibility to adapt quickly to changes in the business or
technological environment.
16) More Employment Creation Capacity:
• Economic planners have realized the necessity of encouraging micro and small
enterprises because they require less capital but generate more employment.
• The micro and small scale sectors have the capacity to generate a much higher
degree of employment than the large-scale sector.
• This is because micro and small scale enterprises are labor intensive and thus
create more employment with a given level of capital. More production needs more
capital in such a situation.
• The micro and small firms will stand in good position because they are less capital
intensive and more labor intensive