Chapter 4

Forms of Business Ownership and

Sources of Funds

08/15/20 1
Chapter Outline
 introduction
Forms of Business Organizations
 Choosing of ownership form
Sources of funds

08/15/20 2
 Introduction
• Entrepreneurs have a vision about what a business might
be like. When thinking about the positives, the vision is
probably one of good fortune, prosperity and success. But,
as you can imagine, unfavorable things may happen.
Revenues may not be enough to pay all the bills, accidents
can happen, and many other contingencies may mean the
entrepreneur has financial responsibilities that must be
met.

08/15/20 3
 Cont..

•There are several ways of going into business and becoming an

entrepreneur. You can:
– Purchase an existing business
– Enter a family business
– Purchase a franchise
– Start your own business

08/15/20 4
 Forms of Business Organizations
• The most common Forms of Business Organization
are:
A. Sole Proprietorship
B. Partnership
C. Corporation
D. cooperatives
E. State owned
business
08/15/20 5
 A. Sole Proprietorship
• Is a form of business organization in which an
individual:
– introduces his capital,
– uses of his own skill and intelligence in the management
of its affairs
– and is solely responsible for the results of its operation.

08/15/20 6
 Cont’d
• The owner of Proprietorship:
– Receives the profits.
– Incurs any losses.
– Is liable for the debts of the business.

08/15/20 7
 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.

08/15/20 8
 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.
08/15/20 9
 Examples of Sole Proprietorship
• Mobile phone repair shops,
• Photo studio, Bookshop,
• Bakeries, small town restaurants,
• Retail stores,
• Radio and watch repair shops,

08/15/20 10
 B. 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.

08/15/20 11
 Types of Partners
• 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.

08/15/20 12
 Other Types of Partners
• 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.

08/15/20 13
 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.

08/15/20 14
 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.

08/15/20 15
 c. 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.

08/15/20 16
 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.
08/15/20 17
 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.

08/15/20 18
 Disadvantages of a Corporation
• Lack of owner’s personal interest.
• Difficulty of formation/Cost and time.
• Delay in decision making.
• Lack of secrecy.
• Potential for diminished managerial incentives.
• Potential loss of control by founder(s).
• Double taxation.

08/15/20 19
 d. 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

08/15/20 20
 Cont..
• Advantages
• Democratic as each member has an equal say.

• Disadvantages
• For members who own a lot of shares they only get one
vote.

08/15/20 21
 state owned business
• A government minister is responsible for each state
company.
• E.g. ethio-telecom, ethio-electric corporation, airline etc.
• They appoint a board of directors.

• The government keeps the profits or re-invests it in the

company.

08/15/20 22
 Reading Assignment
• A. Nationalisation
• B. Privatisation

08/15/20 23
 Choosing of Ownership Form
• There is no one “best” form of ownership.
• The choice of the best form of ownership depends on an
entrepreneur’s desires /needs for
– control,
– participation,
– financing sources, and
– appropriateness of the chosen form for the industry in
which the firm will compete.
08/15/20 24
 Factors Affecting the Choice
• Tax considerations.
• Liability exposure.
• Start-up and future capital requirements.
• Control.
• Managerial ability.
• Business goals.
• Management succession plans.
• Cost of formation.
08/15/20 25
 Sources
Sources of
of Funds:
Funds: Equity
Equity and
and Debt
Debt
• How will you finance your business?
• Where do you find the money? (Source of Capital)

08/15/20 26
 Debt Capital and Equity Capital

08/15/20 27
 Equity Capital
• Represents the personal investment of the owner(s) in the
business.
• Is called risk capital.
• Does not have to be repaid with interest.

08/15/20 28
 Debt Capital
• Must be repaid with interest.
• Is carried as a liability on the company’s balance sheet.
• Can be just as difficult to secure as equity financing.
• Can be expensive, especially for small companies, because of the
risk/return tradeoff.

08/15/20 29
 How will you finance your business?

• Fundamental types of financing are:

– Debt Financing and
– Equity Financing

08/15/20 30
 Debt Financing
• Is borrowing money that is to be repaid over a period of time,
usually with interest.
• The lender does not gain an ownership interest in your
business.
• In smaller businesses, personal guarantees are likely to be
required on most debt instruments.

08/15/20 31
 Sources of Debt Financing
• Commercial banks
• Trade credit
• Equipment suppliers
• Commercial finance companies
• Saving and loan associations
• Small Business Investment Companies (SBICs)
• Small Business Lending Companies (SBLCs)

08/15/20 32
 Five C`s of Credit

 Character
 Capacity (Cash Flow)
 Capital
 Conditions
 Collateral

08/15/20 33
 character
 Individual Attributes
 Passion
 Integrity
 Experience
 Staying Power

08/15/20 34
 Capacity
 Can the business survive?
 Will someone actually purchase the product or service?
 Can the business produce the product or service
economically?
 Can the business make money?

08/15/20 35
 Capital
• What level of paid in capital are the primary funders
contributing?
• What percent of the total capital funding needed is being
requested?
• How is the capital used in the business?
• Is the capital requested reasonable?

08/15/20 36
 Condition
 Potential growth in the market?
 Competition
 Location
 Form of Ownership
 Payoff

08/15/20 37
 Conditions: Banker’s Perspective
 Economy
 Industry
 Interest Rates
 Business Experience
 Individual(s) Experience
 Inflation Rate
 Risk

08/15/20 38
 Equity Financing
• Describes an exchange of money for a share of business
ownership.
• The major disadvantage to equity financing is
– the dilution of your ownership interests and
– the possible loss of control.

08/15/20 39
 Sources of Equity Financing
• Personal savings
• Friends and family members
• Partners
• Angels
• Corporations
• Venture capital companies
• Public stock sale

08/15/20 40
 Personal Savings
• The first place an entrepreneur should look for money.
• The most common source of equity capital for starting a
business.
• Outside investors and lenders expect entrepreneurs to put some
of their own capital into the business before investing theirs idea.

08/15/20 41
 Angels
• Individuals who wish to assist others in their business
venture
• Usually found through networks
• Reasonable expectations on equity position and ROI
• Often passive, but realistic perspective about business
venture

08/15/20 42
 Venture Capitalists (VCs)
• Funds are more specialized versus homogeneous
• Feeder funds are emerging
• Small start-up investments are drying up
• High expectations of equity position and ROI
• New legal environment

08/15/20 43
 Factors affecting type of financing:

Availability of funds.
Assets of the venture.
Prevailing interest rates.

08/15/20 44
 End of
Chapter
Four
08/15/20 45
 (Quiz 3) 5%
• If you are planning to establish a business, which
form of business will you choose?
– Sole proprietorship
– Partnership
– Corporation
• And Why?

08/15/20 46