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.
 Continues….
• 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
 Continues…

• 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
 Continues…
• 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.
 Continues…..
• 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 MSE.
 Continues…..

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.
 Continues…

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
 5. 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.
 Continues…

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
 Continues…..
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.
 Continues…
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.
 Continues….
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.
.
 Continues….

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
 6. Classification of Micro and Small Enterprises
1. In Case of Manufacturing Enterprise (Manufacturing, Construction and Mining):
a) A Micro Enterprise is one in which the investment in plant and machinery (total
asset) does not exceed birr100, 000 (one hundred thousand); and operates with 5 people
including the owner.
b) Small Enterprises is one in which the investment in plant and machinery (a paid up
capital of total asset) of birr100, 000 (one hundred thousand) and not more than Birr 1.5
million; and operates with 6-30 persons.
2. In Case of Service Enterprise (Retailing, Transport, Hotel and Tourism, ICT and
Maintenance):
a) A micro enterprise is one with the values of total asset is not exceeding Birr
50,000(fifty thousands); and operates with 5 persons including the owner of the
enterprise.
b) Small Enterprises is one in which the total asset value or a paid up capital of birr100,
000 (one hundred thousand) and not more than Birr 1.5 million; and operates with 6-30
persons
Continues….
 Priority Sectors and Sub-Sectors for MSEs Engagement In Ethiopia
1. Manufacturing Sector- This is the one which comprises textile and garment; leather and
leather products; food processing and beverage; metal works and engineering, wood works
including furniture and ornaments service; and agro-processing.
2. Construction Sectors- This is the one which comprises sub-contracting; building materials;
traditional mining works; cobble stone; infrastructure sub-contract; and prestigious goods
3. Trade Sectors- This is the one which comprises whole sale of domestic products; retail sale
of domestic products and raw materials supply.
4. Service Sectors- This is the one which comprises small and rural transport service; café
and restaurants; store service; tourism service; canning/packing service; management service;
municipality service; project engineering service; product design & development service;
maintenance service; beauty salon; and electronics software development; decoration and
internet café.
5. Agriculture Sector (Urban Agriculture) - This is the one which comprises modern
• livestock raring; bee production; poultry; modern forest development; vegetables and fruits;
modern irrigation; and animal food processing.
 Levels of MSEs in Ethiopia
• Start-up: Start up level refers to enterprises that incorporate people who are interested to
establish MSE and those who completed the required profession/skill from various
institutions and innovated by legally either in the form of association or private.
• It is a level where an enterprise begins production and service under legal framework or
legal entity.
• Growth Level: An enterprise is said to be at growth level when an enterprise become
competent in price, quality and supply and profitable using the support provided. At this
level, the enterprise man power and total asset is larger than at startup level; and use book
keeping system.
• Maturity Level: Maturity level means when an enterprise able to be profitable and invest
further by fulfilling the definition given to the sector and using the support provided.
Growth- Medium Level: An enterprise is said to be transformed from small to medium
level of growth is when it enabled to be competent in price, quality and supply using the
support given to the level.
 Setting up a 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:
• Stage 1: Discovery
• Step 1: Discovering your entrepreneurial potential
• Self-evaluation and identifying personal resources
• Step 2: Identifying a problem and potential solution
• Solving a problem and meeting a genuine need
• Stage 2: Evaluation
• Step 1: Evaluating the idea as a business opportunity
• Market research and investigating the feasibility of the solution
• Step 2: Investigating and gathering resources
• Understanding the product/service delivery and required resources
• Stage 3: Implementation
• Step 1: Forming the enterprise to create value
• Setting up a business entity and protecting intellectual property
• Step 2: Implementing the entrepreneurial strategy
• Activating marketing, operating, and financial plans
• Step 3: Planning the future
• Visualizing future goals and directions
• Environmental Analysis
• Relationship between entrepreneurship and the environment
• Impact of the environment on entrepreneurship and vice versa
• Conclusion: Importance of following a systematic approach in setting
up a small-scale business
• Summary of the key steps in the entrepreneurial venture
• References/Additional Resources
• List any sources or materials used in the presentation
 Entrepreneurship vs Environment
Analysis of the Environment of Entrepreneurship
(1) Macro Environment
• Political, Technological, Social, Legal, and Economic Environments
• Impact on entrepreneurs, although not immediate
• Understanding these factors is crucial for entrepreneurial success
(2) Title: Sectoral Analysis
• Study of industry/sector conditions
• Puts the proposed venture in the proper context
• Purpose: Determine industry attractiveness (above-normal profits or high growth rates)
• Factors to consider: industry history, future trends, new products, government/industry
forecasts
• Competition, substitutes, entry barriers, bilateral agreements, government policies, challenges
• Constraints: technology, manpower, raw materials
• Strengths of a sector may outweigh negative general trends
(3) SWOT Analysis
• Strengths: Positive internal factors that contribute to accomplishing
goals
• Weaknesses: Negative internal factors that hinder goal
accomplishment
• Opportunities: Positive external options to exploit
• Threats: Negative external forces that hinder goal accomplishment
• Conducting a SWOT analysis helps identify strengths, weaknesses,
opportunities, and threats
(4) Hierarchical Approach to Business Idea Development
• Use opportunities provided by the environment
• Combine unique strengths (knowledge, skills, experience)
• Make a decision to launch a product or service
• Compatibility with entrepreneur's capabilities, available resources,
and societal needs
• In conclusion:
• Analysis of the business environment provides a realistic perspective
• Identifies foundations for building strengths and removing obstacles
• Entrepreneurs can leverage opportunities, their unique strengths, and
societal needs to make informed decisions
 Small Business Failure and Success Factors

• Business failure refers to the closure of a business with a financial loss to

a creditor. It can occur due to various reasons, Inadequate management,
Inadequate financing, Internal problems (capital, cash flow, inventory
control, human resources, leadership, organizational structure,
accounting systems)
• Neglect, fraud, and disasters. but the most common causes are
inadequate management and financing.
Inadequate Management
• Ineffective use of resources
• Lack of experience
• Small business owners as generalists
• Challenges in decision-making
Inadequate Financing
• Shortage of capital
• Improper managerial control
• Insufficient funds at the start
• Mismanagement of resources
Other Contributing Factors
• Neglect: Lack of attention and oversight
• Fraud: Intentional misrepresentation or deception
• Disasters: Natural calamities or unforeseen events
Business Termination vs. Business Failure
• Termination: Ceasing to exist for various reasons
• Failure: Closure with financial loss to a creditor
Common Mistakes Leading to Business Failure
• Neglecting future planning
• Underestimating commitment and hard work
• Resisting delegation as the business grows
• Making inaccurate financial estimates
Keys to Avoid Business Failure
• Embrace planning for direction and adaptability
• Understand dedication and effort required
• Timely hiring and effective employee utilization
• Accurate financial planning for survival
Preventing Business Failure
• Regularly assess the business's viability
• Take action to fix issues, sell, or close if necessary
• Face tough questions, make difficult changes
 Small Business Success Factors
Competitive Advantage of Small Businesses
Identifying competitive advantage, flexibility, customer relationships, and quality are crucial
• Inherent factors that work in their favor
• Identifying competitive advantage
• Remaining flexible and innovative
• Cultivating close customer relationships
• Striving for quality
Symbiotic Relationship with Big Businesses
• Example: John Deere and its network of vendors and dealers
• Small businesses as suppliers and service providers
• Economic opportunities for entrepreneurs
Efficiency in Distribution
• Small businesses excel in distribution
• Linking large manufacturers with consumers efficiently
• Wholesale and retail businesses as intermediaries
Factors for Small Business Success
• Proper attitude and customer orientation
• Providing value for money
• Possessing basic business skills
• Understanding the reasons for business failure
Success Factors Categories
• Conducive Environment
• Political climate
• Economic environment
• Technological advancements
• Socio-cultural environment
• Success Factors Categories (contd.)
Adequate Credit Assistance
• Financing arrangements
• Special financing programs
• Lower interest rates, collateral requirements, equity ratio
• Assistance with project study
• Markets and Marketing Support
• Challenges in the market
• Competition with local and imported goods
• Collaboration through associations or organizations
• Government support in marketing and selling products
 Supporting Packages for MSEs Development in Ethiopia

Main Packages and Challenges

Awareness Creation
• Provide information and raise awareness about the MSE sector in Ethiopia
• Help entrepreneurs understand opportunities, challenges, and potential of
MSEs
• Importance of awareness for starting and developing MSEs
Provision of Legal Services
• Assistance in forming legal business enterprises
• Support in registering businesses, obtaining licenses and permits
• Ensure compliance with legal requirements
Technical and Business Management Training
• Enhance technical skills and business management capabilities
• Training in production techniques, quality control, marketing strategies,
financial management, and human resource management
• Empowering MSE entrepreneurs with necessary skills
• Slide 6:
Financial Support
• Crucial for MSE development
• Mechanisms include personal savings and loans from Microfinance
Institutions (MFIs)
• 20/80 model: Beneficiaries save 20% of project cost, MFIs provide a loan of
80%
Facilitation of Working Premises
• Assistance in finding suitable locations for MSEs
• Negotiating lease agreements
• Access to affordable and well-equipped workspaces
Industry Extension Services and BDS Provision
• Business Development Services (BDS) for MSE support
• Market research, product development, technology adoption,
information access, and networking
• Assistance in improving productivity and competitiveness
Bookkeeping and Audit Services
• Address challenges in maintaining financial records and adhering to accounting standards
• Training or access to bookkeeping and audit services
• Effective financial management for MSEs
Problems of Small Scale Businesses in Ethiopia
• Lack of Adequate Finance and Credit
• Production Problems
• Marketing Challenges
• Lack of Business Management Skills
• Limited Access to Information and Networks
• High Competition
Lack of Adequate Finance and Credit
• Difficulties in accessing finance and credit
• Small size and limited surpluses hinder securing loans
• Reliance on high-interest loans from money lenders
Problem 2: Production Problems
• Struggle to obtain quality raw materials at reasonable prices
• Outdated production techniques
• Lack of funds for investing in new equipment
Marketing Challenges
• Difficulties in effective marketing
• Limited resources and knowledge of marketing strategies
• Hindrance in reaching and attracting customers
Lack of Business Management Skills
• Entrepreneurs lack proper business management skills
• Financial management, strategic planning, and human resource management challenges
• Hampering efficient business operations and decision-making
Limited Access to Information and Networks
• Challenges in accessing crucial information, market trends, and business networks
• Limiting innovation and market reach
• Staying updated becomes difficult
High Competition
• Facing competition from larger, established companies
• Limited resources and economies of scale as challenges
• Need for effective strategies to compete in the market
Organizational Structure and Entrepreneurial Team Formation
• Success depends on commitment, loyalty, and abilities of the
management team
• Full-time commitment and dedication expected from the team
• Drawing a large salary can be perceived as a lack of commitment
Designing the Organization
• Simple structure initially, with the entrepreneur performing all functions
• Additional employees with defined roles as workload increases
• Effective interviewing and hiring procedures for growth and maturity
• Formal structure decisions on roles and responsibilities
• Informal structure or organization culture evolution
• Communication of expectations in various areas
• Manager's decision roles become critical as the organization evolves
• Adapting to changes, responding to pressures, allocating resources, negotiating
contracts
Building the Management Team and a Successful Organization Culture
• Assembling the right mix of people for the organization
• Desired culture matching the business strategy
• Motivating and rewarding employees, flexibility, and thorough hiring process
• Leadership and core values crucial for a positive organization culture
• Hands-on approach to leadership, delegation, and reward system implementation
• Effective team building and positive organization culture critical for venture success
• Importance of innovative and marketable product
• Supporting packages play a vital role in MSEs development in Ethiopia
• Addressing challenges and providing necessary support is crucial
• Organizational structure and entrepreneurial team formation impact venture success
 Question
• Why are small businesses more likely than large businesses to be innovative?