Chapter 4

Chapter 4
Business Formation
Negash L.
Business formation
Business formation deals with the formalization and actual
implementation of business ideas into practice.
The most common Forms of Business Organization are:
♣ Sole Proprietorship : It is a business that is owned exclusively by
one person.
♣ Partnership: it is a business owned by two or more people.
♣ Corporation: it is a business with the legal rights of a person and
which may be owned by many people.
♣ Cooperatives:-It is an organization owned by members who pay
an annual membership fee and share in any profits.
Sole Proprietorship
♠ Is a form of business organization in which an individual:
♠ It introduces his capital
♠ It uses of his own skill and intelligence in the management of its
affairs
♠ It responsible for the results of its operation
♠ Receives the profits.
♠ Incurs any losses.
♠ Is liable for the debts of the business.
Advantages of the Sole Proprietorship
 Simple to create.
 Least costly form to begin.
 Profit incentive.
 Total decision-making authority.
 No special legal restrictions.
 Easy to discontinue.
Disadvantages of the Sole Proprietorship
 Unlimited personal liability.
 Full responsibility for all debts .
 limited managerial experience
 Limited skills and capabilities.
 Feelings of isolation.
 Limited access to capital.
 Lack of continuity.
 The death of owner dissolves the business.
Examples of Sole Proprietorship
 Mobile phone repair shops,
 Photo studio, Bookshop,
 Bakeries, small town restaurants,
 Retail stores,
 Radio and watch repair shops,
Partnership
 Is an association of two or more people who co-own a business.
 Always wise to create a partnership agreement.
 Best partnerships are built on trust and respect.
Types of Partnership
 General partners
 Take an active role in managing a business.
 Have unlimited liability for the partnership’s debts.
 Every partnership must have at least one general partner.
 Limited partners
 Can't participate in the day-to-day management of a company.
 Have limited liability for the partnership’s debts.
 Secret partner
 Takes an active role in managing a partnership but his/her identity is
unknown to the public.
 Silent partner
 His/her identity and involvement is known to the general public, but is
inactive in managing the business.
 Dormant or sleeping partner
 Is neither known to the general public nor active in management.
Advantages of Partnership
 Easy to establish.
 Complementary skills of partners.
 Increase of profit between partners.
 Larger pool of capital.
 Ability to attract limited partners.
 Definite legal status.
 Motivation of important employees.
 Tax advantage over a corporation.
 Flexibility.
Disadvantages of the Partnership
 Unlimited liability of at least one partner.
 Difficulty in disposing of partnership interest.
 Lack of continuity.
 Lack of harmony between partners.
 Potential for personality and authority conflicts.
 Partners bound by law.
Corporation
 Is also known as Joint Stock Company.
 Is an artificial person authorized and recognized by law,
with distinctive name and a common seal.
 It comprises of transferable shares and having a
perpetual succession of life.
Characteristics of Corporation
 Separate legal entity.
 Limited liability.
 Transferability of shares.
 Perpetual existence.
 Common seal.
 Separation of ownership from management.
 Supervision.
 It has a written constitution.
Advantages of the Corporation
 Limited liability of stockholders.
 Ability to attract capital.
 Ability to continue indefinitely.
 Transferable ownership.
 Legal entity status.
 Managerial efficiency.
 Financial strength.
 Scope of expansion is high.
Disadvantages of a Corporation
 Lack of owner’s personal interest.
 Difficulty of formation/Cost and time.
 Delay in decision making.
 Lack of secrecy.
 Potential loss of control by founder(s).
 Double taxation.
Cooperatives
 It is an organization owned by members/customers who pay an annual

membership fee and share profits
 It has to adopt the following principles:
 Members have an equal vote in decisions
 Membership is open to every one who fulfills specified
conditions (e.g. Number of hour worked)
 Assets controlled and usually owned jointly by members
 Profit shared equally between members with limited interest
payment on loans made by members;
 Members benefit from participation, not investment
 Advantages
 Democratic as each member has an equal say.
 Disadvantages
 For members who own a lot of shares they only get one vote.
Several Ways of Going Into Business
 There are several ways of going into business and becoming an
entrepreneur. You can:
 Purchase an existing business
 Enter a family business
 Start your own business
Buying an existing business
Advantages
 Existing businesses already have customers, suppliers, and procedures.
 Seller of the business may be willing to train the new owner.
 There are existing financial records.
 Financial arrangements may be easier.
Disadvantages
 Business may be for sale because it is not making a profit.
 Problems may be inherited with the purchase of an existing business.
 May not have the capital needed to purchase an existing business .
Buying an existing business
Advantages
 Existing businesses already have customers, suppliers, and
procedures.
 Seller of the business may be willing to train the new owner.
 There are existing financial records.
 Financial arrangements may be easier.
Disadvantages
 Business may be for sale because it is not making a profit.
 Problems may be inherited with the purchase of an existing
business.
 Many entrepreneurs may not have the capital needed to
purchase an existing business.
Starting Your Own Business
Advantages of Starting Your Own Business
Independence
Satisfaction
Challenge of creating something new
Triumph when business is profitable
Disadvantages of Starting Your Own Business
Risks
Uncertainty of demand for the product/service
Need to make decisions daily
Intellectual Property Rights
 Intellectual property (IP) rights are the legally recognized exclusive
rights to creations of the mind. Under this law, owners are granted certain
exclusive rights to a variety of intangible assets.
 It is a key element needed to maintain a competitive edge in the market.
 Intellectual property are rights to protect your ideas or innovations
Types of Intellectual Property Rights
 Common types of intellectual property rights include:-
 Patents
 Copyrights
 Trademark
 Trade secrets
Patent
 It grants an inventor the right to exclude others from making, using,
selling, offering to sell, and importing an invention for a limited
period of time, in exchange for the public disclosure of the
invention.
 For new and useful products and
 For processes for the manufacture of new or existing products
Inventions patentable
 Art, Process, Method or Manner of manufacture;
 Machine, Apparatus or other Articles;
 Substances produced by Manufacturing
 Computer Software
 Product Patent for Food/Chemical/Medicines or Drugs
Copyright
 It provides exclusive rights to creative individuals for the
protection of their literary or artistic productions.
 It covers literacy works (novels, poems, and plays), films, music
and etc.
 Artistic works and other works containing intellectual content
such as library works, music, films, sound recordings, computer
programs are covered by copyright.
 A copyright provides exclusive rights to creative individuals for
the protection of their literary or artistic productions.
 Copyright means right not to be copied.
 The copyright is indicated with the symbol ©
 It gives the creator of original work exclusive rights to it, usually
for a limited time.
 It means apply to a wide range of creative, intellectual or artistic
forms or work. For example
Trademark
 It is a recognizable sign, design or expression which distinguished products
or services of a particular trades from the similar products or services of
other traders.
 A trademark is a distinctive name, mark, symbol, or motto identified with a
company’s product(s) and registered at the Patent and Trademark Office.
 Trademark is indicated with the written word “Trademark” or the symbol TM.
Trade Secret
 Any confidential business information which provides an enterprise a
competitive edge may be considered a trade secret.
 For example, Coca-Cola formula
Sources of finance
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 It is an organization owned by members/customers who pay an annual

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