Chapter-Three

Business formation

By: Yeshiwas Fentahun (MA), Lecturer

@ Department of Management ,College
of Business and Economics, Injibara
University
 Concept of Small Business Development

• A business formation: deals with the

formalization and actual implementation
of business ideas in to practice/business
Enterprise.
• Based on socio- economic conditions,
countries define small business differently: All
may use size and economic criteria.
• Size criteria: include number of
employees and the startup capital.
• Economic criteria: covers market share,
independence and personalized
management.
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• Micro and small enterprises (MSEs): Cover a wider
spectrum of industries and play an important role in
both developed and developing economies.
• In Ethiopia MSEs occupy a prominent position in
the development of the Ethiopian economy.
o This is because a small entrepreneurs can set
up with:
o Less capital,
o Enjoy quick returns and
o Flexible to handle the change of the market,
o But they face many problems like
o Lack of finance,
o Poor operations management,
o Lack of experience,
o Poor financial management, etc.
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• Forms of Business
• There are three basic legal forms of business formation
depending on the entrepreneurs’ needs.
o Proprietorship: Form of business with single owner
who has unlimited liability, controls all decisions,
and receives all profits.
o Partnership Two or more individuals having
unlimited liability who have pooled resources to
own a business.
o Corporation: Separate legal entity that is run by
stockholders having limited liability.
o 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.
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o Definition and Role/Importance of MSEs in
Developing Countries
o Definition of MSEs
• Generally, small business is a business that is
privately owned and operated, with a
small number of employees and relatively
low volume of sales.
• Small businesses are playing an important
role in the industrial economy of the
world.
• They are particularly important in the
developing economies.
• Small business is predominant even in
developed countries such as USA, Japan
etc.
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• There are two approaches to define small business.

o Size Criteria: some of the criteria used to measure
size are:
o Number of employees
o volume, and value of sales turnover,
o Asset size, and volume of deposits,
o Total capital investment,
o volume/value of production, and
o A combination of the stated factors.
o Economic/Control Criteria: The economic/control
definition covers:
• Market Share: - The characteristic of a small
firm’s share of the market influence the prices of
national quantities of goods sold to any significant
extent.
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o Independence: means that the owner has control of
the business himself/herself.
• Fairly autonomous, nevertheless have to refer to
major decisions (e.g., On capital investment) to a
higher level of authority.
o Personalized Management: the owner actively
participates in all aspects of the management of
the business, and in all major decision-making
process.
• There is a little delegation of authority and one
person is involved when anything material is involved.
• Technology: Small business is generally labor
intensive and only few are technology intensive.
• Geographical area of operation: The area of
operation of a small firm is often local.
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oRole/Importance of MSEs in
Developing Countries
o Micro and Small Enterprises (MSEs) cover a
wider spectrum of industries and play an
important role in both developed and
developing economies.
o Ethiopia is no exception and MSEs occupy
a prominent position in the development
of the Ethiopian economy.
 Continued ….
o Large Employment Opportunities: MSEs are
generally labor-intensive.
• MSE provides employment opportunities for
more persons.
• Especially MSES are important in a country like
Ethiopia where capital is scarce and labor is
abundant.
o Economical Use of Capital: MSEs need relatively
small amount of capital.
o Hence it is suitable to a country like Ethiopia where
capital is deficient.
o Balanced Regional Development/Removing Regional
Imbalance/: Generally small enterprises are located in
village and small towns.
o Therefore it is possible to have a balanced regional
growth of industries. Ethiopia is a land of
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o 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.
o Higher Standard of Living: MSEs bring higher
national income, higher purchasing power of people
in rural and semi-urban areas.
o 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.
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o 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.
o 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.
o Promotion of Self Employment: MSEs foster
individual skill and initiative and promote self-
employment particularly among the educated
and professional class.
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• Protection of Environment: MSEs help to

protect the environment by reducing the
problem of pollution.
• 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.
• 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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• Individual Tastes, Fashions, and
Personalized Services: Small businesses
have the flexibility to adapt quickly to
changes in the business or technological
environment.
• 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-
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oClassification of Micro and Small
Enterprises
o In Case of Manufacturing Enterprise:
• A Micro Enterprise is one in which the
investment plant and machinery (total
asset) does not exceed birr100,000 and
operates with 5 people including the
owner.
• Small Enterprises is one in which the
investment plant and machinery (a paid
up capital of total asset) of birr100, 000
and not more than Birr 1.5 million(100,000-
1.500,000)and operates with 6-30 persons.
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• In Case of Service Enterprise:
• A micro enterprise is one with the values
of total asset is not exceeding Birr
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
birr100, 000 and not more than Birr 1.5
million(100,000-1,500,000) and operates
with 6-30 persons.
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Priority Sectors and Sub-Sectors for MSEs Engagement
in Ethiopia
• 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.

• Construction Sectors-This is the one which comprises;

• Sub-contracting,
• Building materials,
• Traditional mining works,
• Cobble stone,
• Infrastructure sub-contract, and
• Prestigious goods.
• Trade Sectors- This is the one which comprises whole;
• Sale of domestic products,
• Retail sale of domestic products and
• Raw materials supply.
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• 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.
• 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.
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• Levels of MSEs in Ethiopia
• Start-up:- Start up level refers to enterprises that
incorporate people who are interested to establish MSE.
• 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,
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: - when an enterprise able to be
profitable and invest further.
• Growth- Medium Level:- An enterprise is transformed
from small to medium level of growth when it enabled
to be competent in price, quality and supply using
the support given to the level.
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Setting up Small Scale Business:
o Steps for Setting up the Entrepreneurial Venture
o Discovery: The first stage of discovery is to identify
opportunities that may form the basis of an
entrepreneurial venture.
• It requires creative thinking to identify issues that can
benefit from an entrepreneurial vision.
• This stage can be divided into two steps:
o Step 1 Discovering your entrepreneurial potential -
know more about your personal resources and attributes
through some self-evaluation–
• What will you bring to the venture?
• What are your strengths and challenges? will affect the
type of venture you choose.
o Step2 Identifying a problem and potential solution–
a new venture has to solve a problem and meet a
genuine need.
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• Evaluation: evaluates feasible business in two

further steps:
• Step 3 Evaluating the idea as a business
opportunity– find out information about the market
need.
o Is the solution to this problem really wanted by
enough customers?
o Investigate the feasibility of the proposed solution
(technically, economically, socially, and legally).
• Step 4 Investigating and gathering the
resources –
o How will the product/service get to market?
o How will it make money?
o What resources are required?
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• Exploitation: Identified an opportunity that
has reasonable prospects of success, and
analyzed what is required to launch it and make the
final preparations and launch it into the market.
o It can be developed in three further steps:
• Step 5 Forming the enterprise to create value–
set up a business entity and protect any
intellectual property.
• Get ready to launch the venture in a way that
minimizes risk and maximizes returns.
• Step 6 Implementing the entrepreneurial
strategy – activate the marketing, operating,
and financial plans.
• Step 7 Planning the future – look ahead and
visualize where you want to go.
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• Environmental Analysis: Entrepreneurship
does not exist in a vacuum. It is affected by and
affects the environment.
• Macro Environment
• The macro environment of an entrepreneur
consists of ;
• The political, technological,
• Social, legal and economic environments.
• Sectorial Analysis
• The purpose of industry analysis is to determine
what makes an industry attractive- above
normal profits or high growth rates.
• Sectorial analysis ;
• The history of the industry,
• The future trends,
• New products developed in the industry,
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• SWOT Analysis
• Conducting a SWOT analysis will help the
entrepreneur to clearly identify own
strengths and weaknesses as well as the
opportunities and threats in the
environment.
• Strengths are positive internal factors that
contribute to an individual’s ability to accomplish
his/her mission, goals and objectives.
• Weaknesses are negative internal factors that
inhibit an individual’s ability to accomplish
his/her mission, goals and objectives.
• An entrepreneur should try to magnify his
strengths and overcome or compensate for
his/her weaknesses.
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oOpportunities: are positive external options that
an individual could exploit to accomplish his/her
mission, goals and objectives.
o Opportunities are what an entrepreneur possess certain
unique skills or abilities, which along with his/ her
knowledge and experience can provide him/ her
cutting edge.
o Threats are negative external forces that hinder an
individual from accomplishing his/her mission, goals
and objectives.
o These could arise due to competition, change in
government policy, economic recession,
technological advances etc.
o Threats in the environment can arise from
competition, technological breakthroughs,
change in government policies etc.
 The end
of lesson
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