FORMATION OF BUSINESS

Assessment of new ventures

New venture assessment begins with the idea and venture selection stage. As ideas develop
into a new venture start-up, the challenge is for those firms to survive and grow.

Therefore there needs to be a clear understanding of the critical factors in selecting ventures,
the known reasons for venture failures and effective evaluation process for new ventures.

Pitfalls for selecting new ventures

 Lack of objective evaluation: Many entrepreneurs lack objectivity in evaluating a product

or service idea. They need to subject the idea into the rigorous study and investigation
instead of merely being prone to loving an idea for a product or service.
 Lack of real insight into the market: They ignore the importance of marketing approach in
laying down the foundation for new ventures. They need to project the life cycle of the
new product and the timing of its introduction.
 Inadequate understanding of technical requirements: Development of a new product
involves the new techniques. Failure to anticipate the technical difficulties will sink the
venture.
 Poor financial understanding: Entrepreneurs oftenly underestimates the funds required
to carry the project to completion. Others are ignorant of costs, adequate research and
planning.
 Lack of venture uniqueness: A new venture should be unique, it should provide
performance or service superior to competitors.
 Ignorance of legal issues: Legal issues overlooked includes safe working place,
protections of their inventions, safety of the products etc.

Critical factors for new ventures development

 Relative uniqueness of the venture

 The relative investment size at start-up: the capital can vary depending on the nature of
the industry.
 Growth of sales through the start-up phase: the expected growth of sales or profit as the
venture moves through its start-up phase is also critical factor.
 Product availability during the pre start-up and start-up phase: Lack of product
availability at the time the venture opens its doors affect the ventures' image.
 Customer availability: Venture risk is affected by customer availability for start-up ,
people who are able and willing to pay a profitable price for a product.

Causes of ventures failure

a) Product/market problem
 Poor timing: Premature entry in the market place.

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  Product design problem: The first products are always having some defects
discouraging customers
 Inappropriate distribution strategy: Not geared towards the product and
customers.
 Unclear business definition: Uncertain about the exact business they are in.
 Over reliance on one/few customer: Resulting into failure to diversify
b) Financial difficulties
 Initial under capitalization of the seed and working capital
 Assuming debts too early, taking loans too soon and in large amounts which
require the repayments before the profits started to be generated.
 Venture capital relationship problems: Differing goals, vision,
c) Managerial problems
 Hiring and promotion based on nepotism rather than qualifications
 Poor relationship with parent company
 Founders focusing on their weaknesses rather than their strengths
 Incompetent support professionals eg attorneys who are unable to read and
advice on contract formation.
d) Human resources problems
 High owner ego
 Interpersonal problems
 Employees related conflicts
 Poor monitoring and control of financial material and human resources.

BUSINESS PLAN

A comprehensive business plan is crucial for a start-up business. It defines the entrepreneur's
vision and serves as the firm's resume.

The business plan process helps the entrepreneur shape her original vision into a better
opportunity by raising critical questions, researching answers for those questions, and then
answering them.

Reasons (uses) for writing a business plan:

 Developing the opportunity: To convince oneself that the new venture is worthwhile
before making a significant financial and personal commitment.
 Determining the resources required
 To assist management in goal-setting and long-range planning.
 Equity funding: investors will rarely commit an investment without pursuing the business
plan. Hence the plan attract investors for financing the venture.
 To explain the business to other companies with which it would be useful to create an
alliance or contract.
 Bank finance: Banks need projected balance sheets and profit and loss accounts to
ascertain the viability of the project.
 Recruitment of senior and lower level employees. Good business plan attract
employees.
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  A business plan can help an entrepreneur to allocate resources appropriately, handle
unexpected problems, and make good business decisions.
 A well-organized plan is an essential part of any loan application. It should specify how
the business would repay any borrowed money. The entrepreneur also should take into
account all start-up expenses and potential risks so as not to appear naive.

The basic elements/structure of a standard business plan include:

 Title Page
 Table of Contents
 Executive Summary:
The executive summary is the cornerstone of a good plan. This is the section that people
read in order to decide whether to read the rest. It should concisely summarize the
technical, marketing, financial, and managerial details. More importantly, it needs to
convince the reader that the new venture is a worthy investment.

In your summary you must explain yourself, your team and your background, what your
business is, what is exciting about the proposal, why it will succeed, what you want them
to do – to invest how much, when – and what their reward will be. Whatever the really
key points are, they must be in the summary.
 Company Description/Business background
The company description highlights the entrepreneur's dream, strategy, and goals. It
explains what this business is is all about:
 What is it, what does it do?
 Where does it do it?
 How was it established and when?
 By whom?
 Why?
 Has it been successful and if not why not?
 Product/Service
The product/service section should stress the characteristics and benefits of the new
venture.

Don’t explain the technicalities here, but broadly how it does what it does.
 Where does it do it?
 Is there anything unique about it and have you a patent or other protection on it?
 How is it supplied or distributed?
 Market and Competition
What differentiates it from its competition? Is it innovative?
 Marketing and Selling Strategy
Industry analysis, analysis of specific markets and description of selling and marketing
strategies.
 What is the structure of the market?
 Who do you sell to?
 Why do they buy?
 Why do they buy from you?
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  How do you distribute your product or service?
 Very broadly, who are the competitors?
 How do they compete?
 Operating Plan
 Begins with description of what needs to be done to get the business underway.
it can include detailed plans for buying land, construction, the machinery and its
installation.
 Activities related to security permits and other regulatory compliances
 Assess competing technologies.
 Details of any proprietary.
 Intellectual property issues.
 Number of employees and the needs to expand the work force
Financiers will often have superficial experience of many industries so be prepared for
detailed questions; as much as anything they want to know you really understand your own
business.
There are two reasons why this is particularly important:
a) It may well be that your competitive advantage lies in how you propose to run the
day-to-day business. If you don’t explain this, then how can readers understand
why you are different and how good you are?
b) Readers may have misconceptions of how your industry works that could affect
their appraisal of it, and even if they back you; make your future relationship
difficult.
Therefore:
 Describe processes
 Demonstrate control;
 Highlight differences;
 Show experience.

 Management/Organization
Describing the management and managerial requirements of the venture, management
competence and qualifications.

Give a very brief background on each of the top management team. For each person,
give their age, relevant academic or professional qualifications, experience in the
industry and job they are doing or will do, highlights of past employment experience and
their share stake in the company if they have one.
Put down each person’s achievements and emphasize career progression. Bring out
their experience, qualifications and strengths that are relevant to their current or
proposed role.

 Financing and forecast

This part explains financial requirements and rewards of the venture. The financial
components of a new venture's business plan typically include three projections: a
balance sheet, an income statement, cash-flow analysis and funds flow.

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 These require detailed estimates of expenses and sales. Expenses are relatively easy to
estimate. Sales projections are usually based on market research, and often utilize sales
data for similar products and services produced by competitors.

The amount of financial information that you need to put into a plan will vary with
circumstances and depends upon:
 The size and complexity of the business that you are describing. Clearly a huge
and complex business requiring a large investment will demand a great deal of
detail because the partners and financiers you are communicating with will want
to look at all that detail.
On the other hand, a small business will be simpler to describe and will justify
less investigation.
 Whether the business is already trading. If it is, you need to include up to three
years accounts, if they are available. You must include the most recent year’s
accounts even if they are only available in draft.
 Who the audience for the plan is. For example, you may need to provide far more
financial detail for a financier than for a planning authority.
 The proposal
The proposal is your selling pitch to the reader.

The proposition is what you will do, when and how. The why generally goes without
saying; you want to do it in order to build a profitable enterprise. But, where your plan is
for an enterprise that has social purposes, you will need to explain the why also.
Clearly and concisely explain:
 What you propose to do;
 How you propose to do it;
 Where you propose to do it;
 When you propose to do it;
 Why you will succeed;
 What you need to enable you to carry out the plan;
 What returns you offer.

 Legal and regulatory section:

Stipulates all legal framework and matters that guide the existence and operation of the
business.

There are some important legal issues that arise from sending someone a business plan
or a sales memorandum if they are neither professional investors nor a financial
institution nor professional advisers.

Whether a business plan is sent to a prospective business partner or to a bank or to

staff, there is often an important issue about the confidentiality of the information in it.

There are several ways of dealing with this:

 Get recipients to sign a confidentiality agreement.

 Insert a paragraph at the front of the plan that binds the reader to secrecy.
 Try to omit sensitive information.

 Appendices:

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 These are all attachments or supporting documents. Copies of patents, copyrights,
lease, market research reports, CV of key personnel, technical descriptions, product
brochures etc.

Phases of the business plan

Business plan is divided into three phases:

a) Information collection and analysis:

This phase involves collecting, analyzing and compiling the data necessary to determine
how the business venture operates.
b) Strategy formulation:
The phase plans how to operate the business based upon the data collected. The
strategy is generally in written plans eg marketing plan, operating plan, management
plan and other related plan.
c) Forecasting results:
This phase involves making financial projections that show the expected results of
operating the business. Projections are given in financial statements.

Uses of business plan

 Developing the opportunity

 Determining the resources required
 Equity funding: investors will rarely commit an investment without pursuing the business
plan.
 Bank finance: Banks need projected balance sheets and profit and loss accounts to
ascertain the viability of the project.
 Alliances to form advances with other firms.
 Recruitment of senior and lower level employees.
 Explain the business: a business plan helps in planning in business and strategy
formulation.

SOURCES OF CAPITAL (FINANCING)

Many entrepreneurs struggle to find the capital to start a new business. There are many sources
to consider, so it is important for an entrepreneur to fully explore all financing options.

 Personal savings/own equity:

Experts agree that the best source of capital for any new business is the entrepreneur's
own money. It is easy to use, quick to access, has no payback terms, and requires no
transfer of equity (ownership). Also, it demonstrates to potential investors that the
entrepreneur is willing to risk his own funds and will persevere during hard times.
Advantage of own equity
a) No obligation to repay the money (less burden)
b) Gives more control of business
c) You will retain full business ownership and entitled to 100% profit

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 d) Avoidance of excessive spending. If you fund the business by your own funds
you will try to live within your means.
e) Learn and gain from other shareholders/partners, this happens when more
knowledgeable investor donates funds to business
Disadvantages of own equity
a) This money is always not enough to fund the business
b) May give the strain to the family and personal life. You may have no enough
money left to cover the living cost.
c) In case of business failure, you can lose all your money
d) Lack of commitment and accountability
e) Share of profits: investors expects to share the profit of the business as their
ration of capital invested hence reduces the profit potion of founders.
f) Potential conflicts: This may arise due to sharing the business with people who
has different vision.

 Internal accruals
These are profits and other retained earnings from the business. They can be used to
finance business instead of being taken by owners as profits.
 Friends and family:
These people believe in the entrepreneur, and they are the second easiest source of
funds to access. They do not usually require the paperwork that other lenders require.
However, these funds should be documented and treated like loans. Neither part
ownership nor a decision-making position should be given to these lenders, unless they
have expertise to offer.
The main disadvantage of these funds is that, if the business fails and money goes lost,
a valuable relationship may be jeopardized.
 Bank finance (debt financing):
Banks are very conservative lenders. Many prospective business owners are
disappointed to learn that banks do not make loans to start-up businesses unless there
are outside assets to pledge against borrowing. Many entrepreneurs simply do not have
enough assets to get a secured loan from a lending institution.
However, if an entrepreneur has money in a bank savings account, she can usually
borrow against that money. If an entrepreneur has good credit, it is also relatively easy
to get a personal loan from a bank.
Advantages of debt financing
a) Allow potential greater return on equity
b) Cost of borrowing is low when interest rate is low
c) Lack of relinguishment of ownership (maintaining the ownership of the business)
d) tax reduction through loan interest being charged before tax
e) easier planning: you know in advance exactly how much principal and interest
you will pay back each month.
Disadvantages of debt financing
a) Need of collateral: You need to put business asset as security of the loan, which
is risk.

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 b) Qualification requirement, you need a good enough credit rating to receive
financing
c) Regular interest payment
d) Payback responsibility may cause cash flow problems
e) Heavy debt can inhibit growth and development
 Venture investors:
This is a major source of funding for start-ups that have a strong potential for growth.
However, venture investors insist on retaining part ownership in new businesses that
they fund.
 Taking on new partners
This is the source of capital where the owner of the business invites other people with
capital to join her and have shares of the business.
Advantages of taking in new partner
a) Brainstorming: two heads are better than one head
b) Combined skills and knowledge
c) Lessen financial burdens
d) Improve the quality of process and products
e) Tax benefits: business owned by partners is not subject to tax
f) Sharing of loss
Disadvantages of taking in new partner
a) Risk of disagreement and friction among partners
b) Inability to make quick decisions
c) Reduction of authority to the business
d) Trouble in accounting, investing, profit sharing and resource management
e) Share of profit

 Government programs:
Many national and regional governments offer programs to encourage small- and
medium-sized businesses. These programs assist small firms by acting as a guarantor
of loans made by private institutions for borrowers who may not otherwise qualify for a
commercial loan.

LEGAL FORMS OF AN ORGANIZATION

1. SOLE PROPRIETORSHIP

It is the business owned and operated by one person. It is easy to set-up and is the least costly
among all forms. The individual has the right to all of the profits and obligation to all business
liabilities. He has unlimited liability. Due to its easy formation, it is the most widely used form of
organization.

Advantages

 Ease of formation: There is less formalities and fewer restrictions for establishment
 Sole profit ownership: The proprietor is not required to share with any one the profit
accrued from the business.
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  Decision making and controls are vested to the owner
 Flexibility: the owner is able to quickly respond to business needs without consultation
of anyone else.
 Relative freedom from government control: There is very little government
interference in the operations except for obtaining the license.
 Freedom from corporate taxes: Proprietors are taxed as individual tax payers and not
as the business.
 Fewer overhead costs: the owner may be able to gain higher sales through lowering
prices which is impossible to the larger company.

Disadvantages

 Unlimited liability: He is personally liable for all business debts, the creditors may go
after his personal assets if the business fails to pay debts.
 Lack of continuity: Upon illness, retirement or death of the owner, the enterprise may
be crippled or terminated.
 Lack of capital: Proprietorship has fewer sources of capital than other forms of
organizations.
 Relative difficult in obtaining long term financing: this is because the enterprise
rests exclusive on one person.
 Relative less scope and experience: the ability, training and expertise of one person
limit the direction and scope of the enterprise.
 Lack of economies of scales: due to small size, the enterprise lacks cost advantages
associated with large scale production, purchasing and selling.
2. PARTNERSHIP

Is an association of two or more persons who contribute resources (money, properties, labor,
skills) to the entity. The partners divide the profit and losses of the business among themselves
in the agreed ratio.

Success of partnership depends on trust, commitment, communication quality, joint planning

and joint problem solving.

Advantages

 Ease formation: legal formalities and expenses are fewer compared with those for
companies.
 Direct rewards: they are motivated to put their efforts by direct sharing of the profits.
 Growth and performance facilitated: possibility to obtained more capital and a better
range of skills by infusion of new blood.
 Flexibility: Ability to respond quickly to business needs in the form of day-to-day
decisions.
 Relative freedom from government control: there is little control in its operations from
the government.
 Possible tax advantage: Partners pay tax as an individual thus escaping the higher
rates assessed against companies.
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  Sharing of risks: unlike the sole proprietor, risks affecting the partnership are shared
among partners.
 Retention of individuality: individuality of each partner is not lost in partnership as in a
company.

Disadvantages

 Unlimited liability of at least one partner: At least one partner must be general partner
who assumes unlimited liability.
 Lack of continuity: If a partner dies or withdraws from business, the partnership
arrangement ceases. However, the remaining members can reconstitute a new
partnership.
 Relative difficulty of obtaining large sums of capital: Problems arise especially when
long term financing is involved.
 Binding the partnership: One general partner may bind the partnership in trading
contracts, which unnecessarily commits other partners.
 Difficult of disposing of partnership interest: The buying out of the partner may be
difficult unless special arranged for in the written agreement.

3. CORPORATION

Is an association that has a separate legal personality from its owners. Ownership in a stock
corporation is represented by shares of stock. The owners share profits and losses arising from
the business.

The owners enjoy the limited liabilities but also have limited involvement in company’s
operations.

The board of directors is an elected group from the stock holders to control the activities of the
company.

Requirements in establishing a joint stock corporation/company

a) Memorandum of association: this explains whether the company is private or public, it

also gives the rest of the details of the company.
b) Article of Association: This contains the regulations governing the internal organization.
c) Certificate of incorporation: this is issued by the registrar of companies recognising the
legality of the company as a corporate body and authorizing it to start trading.
d) The prospectus: for a public company, the prospectus invites the public to take share in
the company. It contains information that attracts investors.

Differences between a private and public company

 Shareholders in private companies range from 2 to 50 while in public company there is no

ceiling as to the number of shareholders.
 Shares in public companies are fully transferable where as in private companies they are not.
 A public company requires a prospectus while a private company does not.
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 While public companies are separate from who owns it, private companies can be owned by
the family members.
 There is more of personal though in private company than it is in public company.

Advantages

 Limited liability: The stock holder’s liabilities are limited to the individual’s investment.
 Easy transfer of ownership: Ownership can be transferred through the sale of stock
(shares) to interested buyers. Shares are freely sold and bought in the stock exchange
market.
 Unlimited life of the corporation: The company has the life separate for that of its
owners and can continue for an undefined period.
 Easy in securing capital: Capitan can be acquired through issuance of bonds and
shares of stock, short term loans against business assets and personal guarantees of
main stock holders.
 Increased ability and expertise: Able to draw on expertise and skills of a number of
individuals ranging from major shareholders to professional managers brought to the
business.

Disadvantages

 Activity restrictions: Corporate activities are limited by the carter and by various laws.
 Lack of representation: the majority, who force their will on others, sometimes out-
votes minority shareholders.
 Regulations controls: Extensive government regulations and reports required by the
registrar and local authorities result in a lot of paper works.
 High organizing expenses: there is multitude expenses involved in forming of the
corporation.
 Double taxation: Income taxes are levied both on corporate profit and on individual
salaries and dividends.

4. FRANCHISING

Is the method of distributing goods and services through outlets that are individually owned and
operated, behaving as if they were part of a large chain.

Is the form of patent or trademark license to gain distribution through dealer (franchisee) who
operates under agreed terms and conditions by the franchiser. Eg McDonald’s fast food outlets.

The franchiser gives the right to use the trademark r trade name to the franchisee to produce or
market goods according to certain specifications and standards.

A franchisee pays a one-time franchisee fee plus a percentage of sales revenue as royalty

Advantages

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  Use of proven products and business methods: a product or method has been
tested and their success proven.
 Established business reputation and brand name appeal: The business enjoys a
well developed consumer image and customer goodwill.
 Enjoy strong marketing techniques: the entrepreneur acquires a broad promotion and
publicity used nationally or regionally.
 Opportunity for business training and continued guidance: the franchisee benefits
from franchiser’s expertise in training and guidance.
 Financial assistance: a franchiser can provide a credit or provide the reference to
franchisee to secure loan from banks.
 Managerial assistance: They are assisted in marketing, distribution, merchandising and
inventory management.

Disadvantages

 Lack of absolute independence: the owner has to abide by standard operating

procedures.
 Profit sharing: Payment of royalty and other fees reduce profitability
 Continuous obligation: it is subject to a never ending partnership with the franchiser.
 Unfulfilled promises: Many franchisers do not fulfill the promises they give to
franchisees
 Difficult to cancel the franchise contract: Franchiser has more protection in the
contract. Sometimes the franchisee can’t sell business without the approval from the
franchiser.

Franchise business typically involve heavy investment and long term commitment. Prior to
signing the contract, a proactive franchisee should evaluate the franchise opportunities by
investigating the franchise company itself, product or service to be sold, territory to be served,
contract terms and continuing assistance.

LEGAL AND STATUTORY REQUIREMENTS OF A NEW VENTURE

Major legal concepts that can affect ventures are divided into three categories:

a) Issues relating to inception of ventures; Which includes:

 Laws governing intellectual property eg patents, copyrights, trademarks
 Forms of business eg sole proprietorship, partnership, corporation, franchise.
 Tax considerations
 Capital formation
 Liability questions is it limited or unlimited liability?
b) Issues relating to the ongoing ventures. Which includes:
 Personnel laws (hiring and firing, retention, pension funds)
 Contract laws (sales contact, lease, franchising)
 Changing of government laws which affects the business
c) Issues relating to growth and continuity of ventures. Which includes:

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  Tax consideration (government and local taxes, payroll, incentives)
 Government regulations (Regulatory and administrative agencies)
 Continuity of ownership rights (property laws and ownership, wills, trusts and
estates, bankruptcy)

Importance of legal issues analysis

 To develop legal and regulatory framework that will enable the creation and expansion of
dynamic entrepreneurial ventures.
 To alleviate the difficulties entrepreneurs face in accessing legal advice and information
in legal matters.
 To familiarize with legal and administrative procedures and practices to improve
entrepreneurial activities.
 To familiarize with changing laws, liability situations and complexity of business
formation.

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Protection of intellectual property rights

a) Patent rights
Is the intellectual property right resulted from unique discovery. It provides the owner
with exclusive rights to hold, transfer and/or license the production and sale of the
product or process. Patent holders are provided with protection against infringement by
others.
Items qualify for patent protection include processes, machines, products, composition
of elements (chemical compounds) and improvements on already existing items.

b) Copyrights
A copyright provides exclusive right to creative individual to protect their literary or
artistic productions. It doesn't protect the idea itself and thus someone else can use the
idea or concept in a different manner.
Copyright are desirable for such things like books, periodicals, scripts, articles, poems,
songs, sculptures, models, maps.
The normal remedy for copyright infringement is the recovery of actual damages plus
any profit received by the violator.
c) Trademarks
A trademark is a distinctive name, mark, symbol or motto that identifies the company's
products. One gets an exclusive right to use the mark. If it is properly registered, used or
protected, the owner can obtain an injunction upon any uses of the mark that are likely to
cause confusion. If infringement and damage can be proven in court, a monetary reward
may be given to the trademark holder.
d) Trade secrets
Certain business processes and information cannot be patented, copyrighted or
trademarked. Yet they may be protected as trade secrets. This includes customer lists,
plans, research and development, pricing information, marketing techniques, production
techniques and anything that makes an individual company unique and have value to
competitors.
Problems for protecting intellectual property
 A form of competition that is difficult to combat pirated trademarks. Processes and
patents.
 Computer design software, trademarks brand names are easy to duplicate and difficult
to protect.
 It is difficult to differentiate the intellectual property in the service industry
 Difficult in enforcing the intellectual property laws

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