CHAPTER 3

BUSINESS FORMATION
The Concept of Small Business Development
• A business formation deals with the formalization and actual
implementation of business ideas in to practice.
• 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.
Forms of Business
• There are three basic legal forms of businesses:
Legal Forms Description
• 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.
Definition and Role of MSEs in Developing Countries
• Specifying size and standard to define small business is
necessary
1. Size Criteria
• The criteria used to measure the size of businesses vary; but
size refers to the scale of operation.
• 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.
• Number of employees or capital investment or both has
been used as the basis for defining MSEs in this criteria.
Cont’d…
• Economic/Control Criteria.
• It covers:
• Market Share,
• Independence, and
• Personalized Management.
• Geographical Area of Operation.
Role of MSEs in Developing Countries
• Creation of large employment • Less Dependence on
opportunities Foreign Capital
• Economical Use of Capital • Promotion of Self
• Balanced Regional Development Employment
• Equitable Distribution of Wealth • Protection of Environment
• Dispersal over Wide Areas • Shorter Gestation Period
• Higher Standard of Living • Facilitate Development of
Large Scale Enterprises
• Mobilization of Locals Resources
• Individual Tastes, Fashions,
• Innovative and Productive and Personalized Services
Classification of Micro and Small Enterprises
• In Case of Manufacturing Enterprise (Including Construction
and Mining):
• A Micro Enterprise is one in which the investment in plant
and machinery (total asset) does not exceed ETB 100, 000;
and operates with 5 people including the owner.
• Small Enterprises is one in which the investment in plant and
machinery (a paid up capital of total asset) of ETB 100, 000
and not more than ETB 1.5 million; and operates with 6-30
persons.
Cont’d…
• In Case of Service Enterprise (Retailing, Transport, Hotel
and Tourism, ICT and Maintenance):
• A micro enterprise is one with the values of total asset is not
exceeding ETB 50,000; and operates with 5 persons including
the owner of the enterprise.
• Small Enterprises is one in which the total asset value or a
paid up capital of ETB100, 000 and not more than ETB 1.5
million; and operates with 6-30 persons.
Cont’d…
• Priority Sectors and Sub-Sectors • Levels of MSEs in Ethiopia
for MSEs Engagement In Ethiopia • Start-up
• Manufacturing Sector • Growth Level
• Construction Sectors • Maturity Level
• Trade Sectors • Growth- Medium
• Service Sectors Level
• Agriculture Sector (Urban
Agriculture)
Setting up Small Scale Business
• Steps for Setting up the Entrepreneurial Venture
Environmental analysis
A. Macro environment
Political Environment-stable and conducive political
climate
Technological Environment- new and effective.
Socio-Cultural Environment-customs, norms and
traditions of the society
Legal Environment- The laws of the country
Economic Environment-globalization and opening of the
economy, consumer spending power
B. Sectoral Analysis
Industry conditions
• The purpose of industry analysis is to determine what
makes an industry attractive- this is usually indicated
either by above normal profits or high growth rates.
• For such analysis one should study the history of the
industry, the future trends, new products developed in
the industry, forecasts made by the government or the
industry.
• It is also advisable to study the existing or potential
competition, threat of substitutes and entry barriers.
3. SWOT analysis
• Strength
• Weakness
• Opportunity
• Threats
Small Business Failure and Success Factors
• Business closes as a result of either (1) actions such as bankruptcy,
foreclosure, or voluntary withdrawal from the business with a
financial loss to a creditor; or (2) a court action such as receivership
(taken over involuntarily) or reorganization (receiving protection from
creditors).
• Causes of Business Failure
• Inadequate Management
• Inadequate Financing
• Neglect: do not paying due attention to enterprise.
• Fraud: intentional misrepresentation or deception
• Disaster: some unforeseen happening
Cont’d…
• Mistakes Leading to Business Failure
• Failing to plan for the future
• Failing to understand the commitment and hard work that are
required for turning a business into a success.
• Not hiring additional employees soon enough or not using existing
employees effectively.
• Inaccurate estimates of cash flow and capital requirements
Small Business Success Factors
• Small business success factors can be seen the same as the
efforts exerted in reversing the factors of failure.
• These success factors are categorized as:-
• Conducive Environment;
• Political Climate
• The Economic Environment
• Technology
• Socio-Cultural Environment
• Adequate Credit Assistance;
• Markets and Marketing Support.
Problems of Small Scale Business in Ethiopia
• Lack of adequate finance and credit has always been a major
problem of the Ethiopian small business.
• Not having easy access to the capital.
• Lack of easy access to industrial sources of finance.
• Difficulty to get raw materials of good quality at reasonable
prices in the field of production.
• Outdated technologies/ways of production.
 END OF
CHAPTER THREE