CHAPTER FOUR

MANAGING STARTUP AND GROWTH (MSMS IN FOCUS)

Understanding Micro and Small, and Medium sized Business

4.1. WHAT IS SMALL BUSINESS?

Practically most start ups tend to small or micro or seemingly informal like business.

The terms Micro-enterprise and small-enterprise refer in the first place to the

size of the business. For a long time, the concept of ‘informality’ has also used

to characterize micro and small enterprise, informality here refers to the

informal nature of the employment process (no contract of employment and low

wages) and to the fact that most of such business are not registered. However

for a meaningful classification of firms into categories, the size of firm or the

degree of informality does not provide usable yardsticks. A number of other

characteristics of enterprises and of the entrepreneurs who set up and run them

must also be taken into account. At present in most countries, a combination of

the number of workers and invested capital are used as a yardstick.

The nature and definition of small business varies from country to country. There is no

one universal unifying definition of Small business. Worldwide, countries apply their

own definitions and criteria in defining categories of small-scale enterprise. For

instance definition applied to micro-enterprise in Ethiopia is different from the

developed countries such as the USA and UK – Attempt is therefore made in

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this section to cite some of the definitions given to such categories of enterprise

by different countries including Ethiopia.

The following table indicates the various definitions of small business in selected

countries:

Small business:

 Allow free entry and exit with exception focusing on niche

 Characterized by high level of competition
 Highly demand the management of employee relation

Size Criteria

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Though the criteria used to measure the size of business may vary, the following criteria
are commonly used to measure the size of businesses.

i. Sales volume/market share

ii. Number of employees

Economic/Control Criteria

The definition of a small business referring to economic/control criteria cover the

following:

i. Market share- the market share of a small firm is not large enough to enable
to influence the prices of national goods sold to any significant extent.
ii. Independence-The owner of a small business is independent in that he/she
has full control over the business.
iii. Personalized management- It is the owner who actively participates in all
aspects of the firms’ management and in all major decision making processes.
Thus, there is little or no devolution of delegation of authority.

4.2. SMALL BUSINESS CONTRIBUTIONS

The following are some of the major contribution of MSMEs:

 In most Advanced nations SMEs has significant share in employment creation, and
overall economic development

 According to Ayyagari et al. (2007), in high-income countries formal SMEs

contribute to 50 percent of GDP on average. However, In most LDCs, SMEs
‘seems extension of trading and informal business, usually concentrated on
saturated segments, and seemingly dominated by necessity driven factor’

Some illustrative facts and figure:

 In 2000 in China SMEs created value and services of 50. 5 %, 75 % of job,

60% of china’s export, and 43.2% taxes

 In Japan SMEs account for 70% total labor force

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  SMEs in South Africa contribute 56% of private sector employment , and 36%
of GDP

 Germany economy is based on strong exporting MSEs (largely high tech)

 SMEs contribution is decisive for value generation (51 % of USA’s GDP was
produced by MSEs,35% of south Africa’s GDP as produced by SMEs

Remark:

 In developed countries, SMEs commonly follow “niche strategies,” using high

product quality, flexibility, and responsiveness to customer needs as a means of
competing with large-scale mass producers (see, for- example, Hallberg, 2000,
and Snodgrass and Biggs, 1996).

 Creation and growth of SMEs is an important item on the policy agenda (in all
economies )

Generally, Micro and small enterprises play the following roles:

i. Micro and small enterprises are considered to be greatest value in building up a local
production structure and in promoting economic growth.
ii. Micro and small enterprise are also considered as a means of creating employment
opportunity and achieving a fair distribution of national resource income, knowledge
and power.
iii. Small scale enterprises are also seen as a seedbed for the development of local
entrepreneurship.
iv. Small enterprises are also important in that can help to promote rural industrialization.
v. Small scale enterprises are also termed or seen as forms enterprises in which more
appropriate technology is applied. They require less capital and more labor. They have
the capacity to generate a much higher degree of employment with less capital as
compared to the large-scale sector. Thus, they are less capital intensive and more
employment oriented.

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 vi. Small-scale enterprises are also important in that can serve as suppliers of parts and
accessories to bigger industries. This ancillary function involves specialization in
specific areas and results in greater profitability.
vii. Small-scale enterprises or industries can also play a prominent role in promoting the
export market.

Reflection Exercise:

 Do MSEs are playing governmentally prescribed roles? Such as:

 Employment creation

 Pave industrialization

 Facilitate Backward and forward economic growth

 MSEs do not always contribute towards development of economic growth?

4.3. OPPORTUNITIES AND CHALLENGES OF MSES IN ETHIOPIA

Opportunities for MSEs in Ethiopia

 Major market share for government banks.

 Interest rates are liberalized and at an acceptable level.
 Private banks are gaining terrain and expand to rural areas.
 MSE development supported by government
 Lots of development organizations active in MSE development,
international, national, local, governmental and non-governmental.
 Agriculture is most important sector.
 Growth of informal micro-enterprises to SMEs is supported.
 Informal sector is huge.
 Ethiopia has plenty unused and tradable resources.

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  MSE support strategy is visualized through government development
agencies.
 Workforce in Ethiopia is flexible.
 Retail and manufacturing sector provide most paid employment.
 Internationally (supported) organizations are active in entrepreneurship
education.
 Privatization process will increase and enable competition.

4.4. WHY MSES FAIL (CHALLENGES)?

Small business failure factors:

 Internal or competence related factors

 Incompetency

 Unbalanced experience

 Lack of experience

 Limitation with technical competence

 Inadequate records

 Expansion beyond resources

 Inadequate information about customer

 Failure to diversified market

 Personalized management

 Lack of innovation

 Economy is growing, but highly uncertain.

 Agriculture suffers badly from droughts, especially in North & East.

 Border conflict may trouble activities in the poor North and some unstability in
some regions.

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  Employee protection is rather low.

 Low level of education and literacy.

 Entrepreneurship is poorly educated.

 Self-employment in agriculture is huge.

 Bureaucracy

 Corruption

.
UNCTAD’s (United Nations Conference on Trade and Development) (2011)
assessments of Ethiopia's MSE promotion

 Developing SMEs has proved challenge for Ethiopia

 GTP incorporated the development of SMEs as a strategic target to ensure

accelerated industrial development and job creation (industrial extension program)

UNCTAD recommends:

 Create center for innovation and enterprise development which focus on :

 Building and sustaining awareness of the need for innovation

 Assessing firms needs and matching them with the appropriate service providers

 Mandate of FeMSEDA should be focused with emphasis on enterprise networking

and brokering

 The Government should provide incentives through relevant policy tools (for
example, tax incentives and direct subsidies) to encourage enterprises to train
their workforce with advanced skills

 An “information bank” should be set up to help provide SMEs with information

What are the opportunities challenges and for start ups in Ethiopia?

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 Small businesses often face a variety of problems related to their size. When results that
show micro and small enterprises come to Ethiopia research have been facing some pressing
problems. According to the survey results of Abebe etal, 2009, MSEs in Ethiopia shows a
depressing picture, which is characterized by:

 Simple marketing chains typically involving only two or three players;

 Inadequate market information;
 Crude ranges of products with limited value addition;
 Limited investment;
 Lack of access to credit and training;
 Little or no business planning;
 Limited knowledge of the resource base and
 Inadequate working spaces and sometimes mobile working arrangements

4.5. STRATEGIES FOR MANAGING BUSINESS AT DIFFERENT STAGE OF GROWTH

With focus on Small business

Introduction

 Not all businesses that survive grow to be large businesses. This is due either to
the nature of their industry or simply the personal desires or ambitions of the
owner/manager. And external factors such as (entry of competitors, change in
technology) among others.

 There are more number of start up in developing countries than developed

countries

 Around 75 % of SMEs in some countries disappear before 3 years

 As growth increase advantages to business it also increases complexities and risk

 Practically the stages business passes through are not sequential

 The duration of time a business stay at certain stage varies (depending on

industry attractiveness and other factors)

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 Illustrative to different stages of Small business

 Key growth questions for SMEs

i. How can I secure my company’s future?

ii. How can I sustain my margins?

iii. How can I ensure that my best customers will be my best customers in 3 to 5
years?

iv. How can I develop new customers and market for my products and services as
quickly as possible?

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 v. How can I attract and retain qualified employees?

vi. How I can finance my growth?

MANAGING BUSINESS AT DIFFERENT STAGE:

I. Inception stage / start up/

 The entrepreneurs may be novice or nascent

 The major challenges at this stage:

 Securing customer (limited channel and limited customers)

 The ability to generate and maintain profitability is the challenge

 Start-up commonly managed with few controls, very little performance

assessment and puts emphasis over sales.

 Chasing new customers will be priority

 Rapid growth overwhelms operation and result in operational inefficiency

 The common challenges due to operation inefficiency results due to (inventory

outages, overdue collections, diminishing cash flows, delivery restrictions by
supplier)

 More energy, fiancé and time is required due to increased activity

 Key imperatives

 Develop basic system to manage cash and control receivables, inventory and
payables.

 Develop simple budgets and matrices to track performance and expenditures

 The marketing strategy at this stage will be educate the customer and securing
distribution

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II. Survival stage

 Business looks workable business entity

 At this stage requires more:

 Supervision (suppliers, banks..)

 Working capital

 Features and requirements

 increased complexity of expanded distribution

 Increasing competition challenges

 Focus on price than differentiation

 Introduce formalized cost control system

 Organization outgrows initial system and planning structure

 Difficulties with coordination and control as decentralization increases

 Key imperatives

 Upgrade and formalize systems for control and planning for the future (proactive
planning replaces reactive planning )

 Company outgrows entrepreneurial abilities.

 Entrepreneur unable to delegate

 Internally promoted managers may lack adequate skill

III. Growth stage

 Growth in terms of (sales, profit, market share, expansion, new product

development …)

 Managing growth and ensure resources

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 Develop some new product and look for new source of finance

 Ensure efficient delegation and control

 The challenges emanates from:

 Entry of larger competitors

 The demand for expansion into new market or product

 Finance the growth and maintaining control of operation

 The marketing strategy here customer loyalty must be cultivated, band must be
built

A. Strategy and early growth challenges

 Tendency to over commit, pursue many diverse opportunities.
 lack of clear strategy for how the venture competes
 Imperatives
 Develop a focused strategy that leverages the company’s unique value.
 (what can you do distinctly well and develop capabilities around that)
 Maintain consistency of this strategy with all company activities such as product
development, marketing, operation
 Align capabilities with opportunity
 Original opportunity domain may provide few opportunity for growth
 Competitive pressures and changes in the market may threaten current business
 Imperatives
 Establish competitive uniqueness and move beyond one product orientation
(diversification + expansion)
 Expand into periphery with product and market
 Develop strategy for future that provide new momentum and long-run
effectiveness
 Anticipate / respond to changes in industry / market environment

IV. Decline stage

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  Here marketing Efficiency is important,
 Cash the cow if not kill the dog (exit) strategy is important

4.6. FORMATION OF BUSINESS ORGANIZATION

4.6.1. FORMS OF BUSINESS OWNERSHIP

From point of view of organization or ownership, there are five main forms of
organizations. A business may be organized by an individual as sole proprietorship; by
mutual agreement of two or more persons as partnership; by an association of persons
who form a co-operative society or by a number of persons as a joint stock company or
corporation or else it may be organized by a government as a public enterprise. For
entrepreneurship purposes, however, the chief forms of ownership or organization are:
sole proprietorship, partnership, corporation, franchising and co-operative society.

I. SOLE PROPRIETORSHIP
A form of business organization in which an individual introduces his/her own capital, skill
and intelligence in the management of its affairs and is solely responsible for the results of
its operation known as Sole proprietorship. This form is also known as individual or single

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proprietorship, sole ownership or individual enterprise.
This business is a very common form of ownership carried out in different areas where the
capital required is small and the risk is not heavy. In such form of ownership, speed of
decision is very important and special regard has to be shown to the needs, tastes and
fashions of customers. Examples can be photo studios, bookshops, bakeries, small
restaurants, grocery and retail stores, and other elementary business where a personal
service is important.

Advantages of Sole Proprietorship

 Ease and low cost of formation and dissolution

It is easy to form a sole proprietorship; the legal formalities or other complicated
procedures required are less. Anyone with limited means can start independent
business and gets him/herself employed.
 Direct motivation and personal care
In this form of organization, all the profits of the business belong to one person
who also faces every loss. This gives greater incentive to the owner to take
personal interest in the business and manage it efficiently. As only one person is
dealing with the business, the proprietor can come into close contact with the
customers; and earn goodwill by attending the customers' demands promptly and
satisfactorily.
 Freedom and promptness in action
In matters of business dealing, the sole proprietor can take his/her own decision
and there is no question to his/her authority. This type of freedom of action
promotes initiative and self-reliance. As there is no need to consult other persons,
the sole proprietor can take prompt decision.
 Business secrecy
In this type of business, it is easy to maintain the secrecy of business. Since
confidential information is a key to success for a competitive business, it is
unlikely that the owner will leak the information. Thus, any change he/she wants
to make regarding business methods or policies can be done without the
knowledge of others.

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  Social desirability
From the social point of view, the sole proprietorship is desirable as it ensures
that too much wealth does not concentrate in the hands of few. It may be one of
the ways in which equitable distribution of wealth is ensured. In addition, the
unlimited liability of the proprietor ensures members of the society involving in
these forms of business organization to put forth their maximum effort, which
indirectly helps the society to prosper.

Disadvantages of Sole Proprietorship

 Limited resource and size

In this type of concerns, the resources, that is, the capital and skill are very
limited. As only one person is responsible for the business, capital is limited to
his/her capacity. Lending institutions may hesitate to lend large sum of money,
and suppliers may be unwilling to make credit sales in large quantities to such a
business because it is neither safe nor dependable, which makes the business to
remain limited in size.
 Unlimited liability
The sole proprietor will be legally liable for all debts of the business. At times of
loss and bankruptcy, if the business asset is not sufficient to satisfy the obligations
or debts of creditors, her personal and real property may be required to pay off.
This concept of unlimited liability is on the one hand a source of courage and real
devotion. On the other hand, it makes the owner to be fearful and averse to risk.
 Limited management skill
While running a business many complex and difficult problems may arise
requiring wide array of knowledge in management. This makes the possibility of
solving the problems difficult for the sole proprietor in such form of business.

 Uncertain future
This kind of business suffers from instability or lack of continuity. This business
may come to end if the owner cannot continue to run the business due to death,
insanity, imprisonment or bankruptcy.

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 II. PARTNERSHIP
When it will be difficult to find a single person possessing adequate capital, technical skill,
knowledge, and managerial experience; there arises a need for a formation of business
where two or more persons join together, contribute their capital and skills. This form of
association of two or more persons to carry on a business as co-owners for profit whereby
the relationship is based on agreement is known as partnership. The following are general
characteristics of a partnership:
a. Formation
This form of business requires the existence of two or more persons entering into a
contract.
b. Capital contribution
In this form of business, every partner shall make a contribution which may be in
money, debts, other property or skill.
c. Management
Every partner has the right to take an active part in the management of the firm's affair.
But the partnership agreement may provide the pattern of managing by indicating how
the management activity is shared among the different partners according to their
experience and knowledge.
d. Duration
The partnership firm legally comes to an end if any of the partners withdraws or is no
longer able to be a partner under the law or declared bankrupt. However, if the
remaining partners agree to work together under the original firm name and style, the
firm will not be dissolved and will continue its business after settling the claims of the
outgoing partner. Under some conditions, the business organization can be dissolved if
the purpose has been achieved or cannot be achieved and where the partners agree to
dissolution prior to the expiry of the term for which the business was formed.

e. Other legal characters

 Unlimited liability: The liability of each partner of the firm is unlimited in
respect of the firm's debts. The liability of partners is joint; in a sense that the
creditors can recover their dues from the property of any or all partners in case

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 the firm's assets are insufficient.
 Implied agency: The partner will be liable for the faults and wrongful acts of a
co-partner while acting for the business. Since every partner has the right to
take part in the management activity, when acting on his/her given a specified
area, every partner has an authority to act on behalf of his/her fellow partners
and the firm in the ordinary course of business. Thus, he/she is an agent of the
firm and that of the other partners. This indicates that the firm is responsible
for every mistake or fraud committed by the partner in the course of business
and the partner's knowledge will be treated as knowledge of the firm because
he/ she is an agent of the firm and that of other partners. Outside parties which
enter into a contract with a partner are entitled to believe that the firm also
agrees to the contact.
 Utmost good faith: there must be the highest standard of honest among
partners. Partnership agreement is based on mutual confidence and trust of
partners.
 No separate legal entity: the partnership firm has no independent legal
existence apart from the persons who constitute it. In the eyes of the law, there
is no distinction between the partners and the firm.
 Restriction on transfer of interest: A partner cannot transfer his/her share
or give his/her ownership to outsiders without the consent of other partners.
 Unanimity of consent: No change may be made in the nature of business and
no partner can act out of the specified way or make major and special decision
without the consent of all the partners.

Types of Partnership

 General Partnership: This form of partnership consists of partners who are

jointly, severally, partially and fully liable as between themselves and to the
partnership undertaking. Under this form, all the parties who are named as the
general partners have unlimited liability that is, if the business asset is
insufficient, debt coverage goes to the extent of the partners' personal assets.
The partners also face the risk of implied authority in a sense that the partners

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 will be liable for the wrongful acts of a co-partner in the course of the firm's
business. More importantly, the general partners have the right to actively
participate in the management affair of the business. Therefore, the ongoing
discussion about partnership basically refers to this type of partnership.
 Limited Partnership: This type of partnership is a firm that necessarily consists
of two classes of partners: the general partners who are liable jointly, severally
and who retain all the rights and obligations and limited partners who are only
liable to the extent of their contribution in the business. In other words, a limited
partnership has at least one general partner and at least one limited partner. The
limited partners are basically required to increase the capital of the business.
Since their liability is limited, their rights are also restricted and they cannot
take part in the management of the business and their act does not bind the firm.
The limited partners have the right to inspect the books of the firm for their
information and may advise the general partners. Again, the retirement, death,
insanity or bankruptcy of these special partners does not dissolve the
partnership. The limited partner cannot assign her share to an outsider without
the consent of the general partners. A limited partner should be registered under
the law. It is necessary to provide information to the public about the capital
contribution of the limited partners and the extent of their liability. The firm
should make public who are the limited partners and general partners so that
outsiders could specifically know whose personal assets they can claim at times
when business assets are not sufficient to cover debts and other obligations.
Non-registration or no publicity makes the limited partners to be treated as
general partners and the liability will be unlimited.

Advantages of Partnership

 Ease of organization: Except some formality, partnership is quiet easily formed.

All that is required is an agreement among partners. The initial expenses are less
and legal formalities are simple.
 Large financial and managerial resources: compared sole proprietorship, in this
form of organization the capital to be raised will be more because the financial

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 resources of two or more persons will be available and this will make the business
to enjoy high credit standing and get more credit. Moreover, because the talents
and management of two or more persons are combined, the venture will be better
managed.
 Personal supervision: partners look after the business personally and guard
against wastage and other inefficiencies because they are initially interested in the
success of the business
 Reduced risk: The loss incurred by the firm will be shared by all partners and
hence the share of lose each partner will be less than the one in the case of sole
proprietorship.

Disadvantage of partnership

 Unlimited liability: if the assets of the partnership are not sufficient to meet
the obligation creditors may choose to sue any or all to satisfy the debts.
 Risk of implied authority: a dishonest or incompetent partner, by his/her
acts, misjudgment or fault, may put the firm in difficulties because his/her acts
would bind the firm and the remaining partners.
 Lack of harmony: As every partner has equal voice in the management,
everyone would try to promote his/her personal interest, which may lead to
internal frictions and misunderstandings.
 Lack of continuity: partnerships may come to an end, even though not in all
cases, due to death, retirement, or withdrawal of a partner for any reasons like
dissatisfaction, bankruptcy, or any serious disagreement among partners or by
court order.

III. CORPORATION (JOINT STOCK COMPANY)

Corporation is defined as an artificial person recognized by law, with distinctive name, a
common seal comprising transferable shares of fixed values, carrying limited liability, and
having a perpetual existence.

Features of corporation

a. Separate legal entity: The rights and privileges are given to the corporation by its

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 charter (charter is an instrument granting the corporation the right to operate and
defines the restrictions and procedures under which it may do so), which is granted by the
state in which it is incorporated. Thus, the corporation becomes a legal entity and is
granted the right to manage its own affairs, the right to sue and be sued, and the right to
own and dispose property.
b. Limited liability: Since the company is a separate legal entity, its debts are its own.
Shareholders of the corporation cannot be held liable to pay more than the face value of
the share standing in their names or the contribution made. In other words, personal
assets will not be required to cover debts and other obligations in case the business fails
to settle.
c. Transferability of shares: Shareholders can transfer their share to others without
consulting other shareholders. The owners can sell their shares or give freely for anyone
as they wish without the consent of other shareholders.
d. Perpetual existence: A corporation can be dissolved in only three ways; by court order,
by the approval of the majority of the stockholders or by expiration of the corporate
charter. Corporation is not affected' or interrupted by the death, insolvency or
retirement of any shareholder or director.
e. Common seal: A company, not being a natural person, cannot sign documents for itself.
Therefore, the common seal with the name of the company engraved on it is used as a
substitute for its signature.
f. Separation of ownership from management: Here all owners, large in number, do not
have the opportunity of managing the day-to-day working of the company. The
shareholders who own the capital are kind of absentee owners who are engaged in their
respective locations or activities while holding shares of the company.
Corporate Structure: There are three groups that comprise the corporate structure: the
shareholders, the board of directors and the officers of the corporation.
Stockholders: The stockholders are owners of the corporation. They are individuals who
buy shares of stock that show proof of ownership. Stockholders do not own property in
same legal sense that the proprietor or partners do in the other forms of ownership.
Besides, the corporation must have a charter. A corporate charter is the written by law of
the company and usually contains:
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 Name and address of the corporation
Names and addresses of the directors
 The purposes for which the corporation is formed
 Amount and kind of stock to be authorized (common/preferred stock)
 Privileges and voting power of each stock
 Duration of life of the corporation

On approval, the charter becomes a three-way contact between the state and the
stockholders, the stockholders and the corporation, and the incorporators and the state.

By electing a board of directors, stakeholders delegate their authority and usually exercise
only indirect control over the affairs of the business. The board of directors, which consists
of three to twelve individuals in Ethiopia, is the chief governing body of the corporation.
Because they hold a position of great trust, directors may be held personally liable to the
stockholders for gross negligence, fraud, or the use of corporate assets for their personal
gains. They cannot be liable for mistakes in business judgment. The board of directors is
responsible for the following activities.
 Declaration of dividends: the board has the sole responsibility of declaring dividends.
This involves such decisions as the percentage of the earnings to be retained and the
method of dividend payment (cash and/or stock).
 Major decision making: the board decides on major areas including expansion,
withdrawal, change of product, and the selection of the corporate officers.

The board of directors elects the officers of the corporation who are directly responsible
for running the corporation. The board usually appoints a president, executive vice
president and a number of additional vice presidents who are responsible for various
divisions of the firm. These officers act as agents of the firm because they have the power
to bind the corporation in contracts.

Advantages of Corporation

i. Financial strength: Corporations can raise a large amount of capital by issuing shares
to the general public. They can also expand as long as investors are willing to purchase
additional shares of stock. Corporations find it easier to borrow large sums of money

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 because the amount pays large interests to those agencies that market securities.
ii. Limited liability: The shareholder's liability is limited to the extent of the face value
of her share in the corporation. Thus, the organization can attract more investors who
do not want to take more risk. The creditors cannot look beyond the assets of the
corporation to settle their debts because the corporation is a separate legal entity that
owes all the debt.
iii. Scope of expansion: As large capital is invested, it would be possible to use up-to-
date equipment and expensive machinery and carryout operation at large scale. This
will make the cost of production less resulting in a higher profit and creating the
possibility to have big reserve that can be used for the expansion of the company.
iv. Stability: Corporations enjoy perpetual succession. That is bankruptcy, insanity or
death of a shareholder, change in management, or dispute over the ownership cannot
affect the continuity of a corporation. Thus, corporations are well suited for business
which requires a long period to establish and consolidate.
v. Efficient and bolder management: There is availability of managerial talent because
the most efficient persons may be chosen as directors and if found unsatisfactory they
can be fired. Since the persons who manage the company have relatively smaller
financial stake, they will have an adventurous spirit to take big risks and bring success
to the business.
vi. Diffused risk: The risk is spread over several members of the company and is reduced
for each member, which helps the business to attract more investors and to venture on
new opportunities.
vii. Voting: Normally, each share of stocks carries with it one vote. If a shareholder can be
present at the meeting, they may cast their votes in person. If, as is more likely, they
cannot attend the meeting, they may send their proxy, which is a written authorization
for someone else to cast their votes for them.

Disadvantages of Corporation

i. Difficulty of formation: Before a company can start functioning there are numerous
requirements of law to be complied with. Generally, the legal procedures required to
establish corporations are very complicated and lengthy. In addition, establishing

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 corporations requires huge sum of money, and thus large number of people have to be
approached for raising the required capital.
ii. Lack of owner's personal interest: these forms of organizations are managed by
directors and paid officials and employees who may not be expected to have such an
intense interest in the success of the business. Besides, the owners who usually own a
very small of the business will not put forth their maximum effort on the total success
of the business like the previous forms of organizations.
iii. Delay in decision-making: Corporations do not enjoy the same amount of flexibility
and promptness of decisions as the other forms of business do. Decisions, specially,
on key issues requiring general meeting of share holders may be delayed because of
the time interval between meeting, difficulty of getting the required number of
members to pass decisions and the presence of diverse interests which may lead to
disagreements.
iv. Oligarchic fraudulent management: Though in theory, it is said democratic
principles are followed in the management of corporations, in practice the
concentration of managing power is in the few hands of the managing directors thus
leading to oligarchy of managing or rule- by few. Many times dishonest persons at
the top succeed in cleverly misleading and cheating the shareholders and as a result
leading the companies to be managed by cheating and fraudulent hands.
v. Double tax: on the average, not less than forty percent of the profit is taxed as federal
income tax. Corporate profit tax and personal income tax on shareholders’ dividends
by states are common taxes imposed on corporations.
vi. Lack of secrecy: Corporations are required by law to report their financial
performance annually to the general public. Therefore, the large corporation is
unable to keep confidential certain areas such as profits or dividends. This allows
competitors to alter their plans based on the corporation’s open books.

IV. FRANCHISING
Today, more than a third of all retailer sales and an increasing part of the gross domestic
products are generated by private franchises. Franchising is a marketing system that revolves
around a two-party legal agreement whereby one party is granted the privilege to conduct

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business as individual owner, but is required to operate according to certain terms and methods
specified by the other party. The legal agreement is known as the franchise contract, and the
privilege it contains is called the Franchise. The sponsor of the privileges is the Franchisor. The
party that receives the privilege is called the Franchisee.

Why Franchising Venture?

What do you think are the reasons for some entrepreneurs to establish a venture through
franchising contract? There are a number of advantages associated with franchising that have
potential to convince entrepreneurs to choose franchising over other venues for business:

Training and Guidance: - Perhaps the greatest advantage of buying a franchise, as compared to
starting a new business or buying an existing one, is that the franchisor will usually provide
both training and guidance to the franchisee. As a result, the likelihood of success is much
greater for national franchisees who have received this assistance than for small-business
owners in general.

Brand-Name Appeal: - An individual who buys a well-known national franchise, especially a

big-name one, has a good chance to succeed. The franchisor’s name is a drawing card for the
establishment, and people are often more aware of the product or service offered by a national
franchise and prefer it to those offered by lesser-known outlets.

A Proven Track Record: - Another benefit of buying a franchise is that the franchisor has
already proved the operation can be successful. If all of the other units are still in operation and
the owners report they are doing well financially, one can be certain that the franchisor has
proved that the layout and location of the overall management system are successful.

Financial Assistance: - Another reason that makes a franchise a good investment is that the
franchisor may be able to help the new owner secure the financial assistance needed to run the
operation. In fact, some franchisors have personally helped the franchisee get started by lending
money and by avoiding requiring any repayment until the operation is running smoothly.

V. CO-OPERATIVES
Co-operatives can be defined in the widest sense as voluntary organization of economic
units, based on equity, carrying out an allocated or self-given economic objective.

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Features of co-operatives

i. Open membership: a co-operatives society is a voluntary association of persons and

not of capital, therefore; any person can join a co-operatives society of his/her free will
and can leave it at any time after giving due notice to the society. While leaving,
he/she can withdraw his/her capital from the society but, cannot transfer his/her
share to another person.
ii. Equality of voting rights: in a co-operatives society, each one of the members
has only one vote no matter what proportion the capital he/she has contributed. One
man, one vote, is the basic principle.
iii. Democratic control: In this form of organization, there is self-administration of
the society based on the equality of all members. The influence on decision-making is
not related to capital invested but to the participation of the person. The supreme
power in the co-operative society is the assembly of its members, the general meeting
that is usually well attended by members as they are from the same local area. It is also
the members that approve the policy and by-laws of the co-operatives.
iv. Disposal of profit or surplus: In co-operative societies, any excess income is divided
between allocations for reserve fund and distribution for members. The amount
allocated as a reserve fund is used for covering any contingencies and for expansion of
the business. The reserve fund is also used for improving the quality of life of the
community.
The actual distribution of income to members takes two forms.
 Return paid on the capital invested by members is considered as form of interest
rather than dividends.
 Patronage refunds or rebates method profit, which is distributed in relation to the
members' contribution to the society.
v. Service motto: A co-operative society is organized primarily with the objective of
rendering maximum service to its members in a certain field. It does not aim at profit at
the cost of its members, for it is formed basically to provide certain essential facilities to
its members. This does not mean that a co-operative society will never work for profit.
It is quite usual to such societies to make profits by extending services to non-members.

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vi. The capital for the enterprise is subscribed only by members.

Types of Co-operatives

The principal types of co-operatives are the following.

A. Consumers’ Co-operatives: These societies are formed by ordinary people for their
day to day requirements of goods at cheap prices. These societies make their purchases
in bulk from wholesalers at whole sale rates and sell the goods to members and
sometimes even to non-members.
B. Producers' Co-operatives (industrial Co-operatives): These are business enterprises
organized by small producers for securing some of the benefits of large producers. The
objective is to assist the small producers that suffer from lack of capital and other
equipment.
C. Marketing Co-operatives: marketing co-operatives are voluntary associations of
independent producers organized to arrange for the sale of their output.
D. Housing Co-operatives: These are associations of persons who are interested either in
securing the ownership of a house or in obtaining accommodation at fair and
reasonable rents.
E. Credit Co-operatives: These are voluntary associations of persons with moderate
means formed with the objective of extending and developing short-term financial
accommodation and the habit of saving among the members.
F. Co-operative farming societies: The co-operative farming societies are basically
agricultural co-operatives formed with the objective of achieving the benefits of large-
scale farming and maximizing agricultural output. Such societies are advocated for those
agricultural countries that" suffer from fragmentation and sub-division of agricultural
holdings of farmers.
G. processing co-operatives
H. labor and construction co-operatives

Advantages of Co-operatives

i. Democratic management: The management of a co-operative society is based on the

basic democratic principle of one-man-one-vote. A small group of members cannot

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 dominate its affairs even if it happens to command more capital than the other members
do.
ii. Limited liability: The liability of the members of a co-operative is limited to a
certain proportion of their capital contribution mentioned in the by-laws.
iii. Continuity: The life of a co-operative society is not affected by the death,
insolvency or conviction of a member.
iv. Tax concessions: The law may give a preferential treatment to co operatives in the
form of concessions and exemptions below a specified amount of income.
v. State assistance: Since a co-operation is an instrument of the economic policy of the
government, the state offers many types of assistance including cheap loan assistance to
co-operatives.

Disadvantages of Co-operatives

i. Insufficient motivation to the members: Co-operatives lack the profit-making

incentive common to other forms of business, which appears to be a serious problem.
This will result in insufficient motivation to the members.
ii. The tendency to depend on volunteers: Normally, members of the executive
committee are not paid for their services, and the salary scales for employees are
frequently on the low side. This will result in inefficiency of management.
iii. Excessive state regulation: Excessive state regulation causes lack of flexibility in
the co-operatives affairs.
iv. Limitation of capital: Often co-operatives face shortage of capital as most members
come from limited areas and means.

VI. PUBLIC ENTERPRISES

A public enterprise is one that is organized by a federal, state or city government for the
purpose of conducting public business. Cities and towns become incorporated to conduct
normal business. Public enterprises may arise as a result of nationalization of private
enterprises and the establishments of new plants by the state. However, public enterprises
will not be discussed further because they are not directly related to entrepreneurship.
Characteristics Most advantageous Least advantageous

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 form form
Availability of capital Corporation Sole proprietorship
Cost of organization Sole proprietorship Corporation
Ease of organization Sole proprietorship Corporation
Ease of expansion Corporation Sole proprietorship
Ease of dissolution Sole proprietorship Corporation
Ease to transfer ownership Corporation Sole proprietorship
Ease of withdrawing from ownership Corporation Sole proprietorship
Efficiency of management Corporation Sole proprietorship
Government controls Partnership Corporation
Length of life Corporation Sole proprietorship
Liability of owners Corporation Sole proprietorship
Secrecy of operation Sole proprietorship Corporation
Tax position of owners Sole proprietorship Corporation
Tax position of operations Sole proprietorship Corporation
Table1. Comparison of sole proprietorship, partnership and corporations

4.6.2. CRITERION FOR CHOOSING BUSINESS OWNERSHIP

In choosing a particular form of organization, an entrepreneur will try to find out how far
his/her requirements will be met by a particular form of organization. Entrepreneurs will
generally consider the following factors while making this type of assessment.

 Ease of Formation
An ideal form of organization is one that can be brought into existence with the
least difficulty. A good form of organization, as judged from the point of view of
ease of formation is one that involves the least expense in formation and minimum
legal formalities.
 Ease of Raising Capital
Where a large amount of capital is needed, it is desirable to ensure that investors
in the business are assured of safety of investment, fair return on investment and
the transferability of investment.
 Limited Liability

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 From the point of view of risk, the entrepreneur will naturally prefer limited
liability. That is in case of insolvency or winding up, the owners will be held
responsible only up to the amount of capital contributed by them while
establishing the business.
 Direct Relationship between Ownership Control and Management
The right of an individual or a group of individuals represents ownership of a
business. As a rule, the control should lie where the ownership lies. This will
ensure that the management will take active interest in the efficient running of the
enterprise. If the responsibility for management or the control of management is
not with the owners, the management may not have a direct personal interest in
maximizing profits through increased efficiency.
 Flexibility of Operation
A good form of organization offers the maximum flexibility and adaptability to
situations. That is the organization should lend itself to change and adjustment
without much difficulty as the need be.
 Continuity or Stability
. An ideal form of organization enjoys uninterrupted existence over a long period.
From the entrepreneur's viewpoint, it is important that he/she be able to
formulate plans for the future and make investments paying for considerable
periods. From the social point of view also, it is desirable that there be an agency
that meets its economic needs continuously and provides continuous employment
to the society.
 Keeping of Business Secrets
The entrepreneur will also have to be careful to ensure that the form of
organization chosen will allow the vital business secrets to be kept confidential.
 Freedom from State Regulation
Various forms of organizations are exposed to varying degrees of control and
regulation by state. Where the extent of regulation by government is considerable,
the enterprise may have to spend considerable amount of time, money and energy
in complying with legal formalities and instructions.
 Low Tax Liability
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 Various forms of organizations are assessed to income tax on different bases.
Obviously, other things being equal, the ideal form of organization will be that
which attracts the minimum amount of tax liability.

4.6.3. LEGAL REQUIREMENTS

To operate as a legal businessperson and protect the business from unnecessary suits and
liabilities, the entrepreneur needs to understand the various laws that govern his/her business. The
following are the key legal issues for the entrepreneur.

I. Patents

One of the avenues to the establishment of the new business is invention. An entrepreneur who
invents a new thing or improves an existing invention needs to get legal protection for his/her
invention through a patent right. A patent is a contract between an inventor and the government
in which the government, in exchange for disclosure of the invention, grants the inventor the
exclusive right to enjoy the benefits resulting from the possession of the patent. A patent prevents
anyone except the inventor from making, using or selling the invention for a specified amount of
time.

II. Copyrights

A Copyright protects the original works of authorship. However, it does not protect the idea
itself, and therefore it allows anyone to use the idea in different manner. Among the things that
need to be protected through copyright arc music, books, software, scripts, articles, poems,
sculptures, models, maps and blueprints.

III. Trademarks

A trademark is a word, symbol, design or some combination of these, or a slogan or a particular

sound that identifies the source or sponsorship of certain goods and services. For instance, the
stylish word "Coca-Cola" that you see on a coca-cola bottle is a trademark. To legally secure the
exclusive use of such a mark, the trademark has to be registered with the concerned body.

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