CHAPTER 4: Entrepreneurship, Small Business, and New Venture Creation 1

CHAPTER 4:

Entrepreneurship, Small Business, and New Venture Creation

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After reading this chapter, you should be able to:1. Explain the meaning and Interrelationship of the

terms small business, new venture creation, and entrepreneurship.

2. Describe the role of small and new businesses in the Canadian economy.

3. Explain the entrepreneurial process and describe its three key elements.

2009 Pearson Education, Inc.

L E A R N I N G O B J E C T I V E SL E A R N I N G O B J E C T I V E S

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After reading this chapter, you should be able to:1. Describe three alternative strategies for becoming a

business owner-starting from scratch, buying an existing business, and buying a franchise.

2. Describe four forms of legal organization for a business and discuss the advantages and disadvantages of each.

3. Identify four key reasons for success in small businesses and four key reasons for failure.

L E A R N I N G O B J E C T I V E S (cont’d)L E A R N I N G O B J E C T I V E S (cont’d)

© 2009 Pearson Education, Inc.3

What’s in It for Me?

• By understanding the material discussed in this chapter, you’ll be better prepared to:

1. Understand the keys to entrepreneurial success, including business planning

2. Discuss the reasons for success or failure3. Evaluate the advantages and

disadvantages of different kinds of ownership


Exercise A. Write down one example of a small

business that you visit frequently. Then write down why you think it is important for this small business and others like it to be part of Gaza economy.

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Small businesses in Canada

1. In 2009, the number of self-employed Canadians increased by 115 000.

2. Every day, approximately 380 businesses are started in Canada.

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Small business (SM)Defining a "small" business can be a bit

tricky. Various measures might be used,

including the number of people the business employs, the company's sales revenue, the size of the investment required, or the type of ownership structure the business has.

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SM in CanadaA. A goods producing business in the Register is

considered small if it has fewer than 100 employees.

B. while a service producing business is considered small if it has fewer than 50 employees.

C. Industry Canada reports that there are 2.3 million “ small business establishments" in Canada and about 2.6 million people who are "self-employed."

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SM contribution to GDP in Canada

A. small business's contribution to Canada's GDP over the past decade at 26 percent annually

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What Is a “Small” Business?• Small Business Defined

–A business that is independent (not part of a larger business) and that has relatively little influence in its market.

• A new venture as a recently formed commercial organization that provides goods and/or services for sale.


What Is a “Small” Business?• Why Small Business is important in the

Economy– Job creation: more than half of all new jobs

created in the U.S. are by small businesses.– Innovation: Most new innovative product

or service ideas come from small businesses. E.g., PC, photocopier.

– Contributions to big business: • Suppliers of specialized services and raw

materials• Sellers of larger firms’ products


FIGURE 3.2: Small Business by Industry


Entrepreneurship• EntrepreneurshipThe process of seeking business opportunities under

conditions of risk and accessing the resources needed to capitalize on that opportunity.

• Entrepreneur– One who accepts the risks and opportunities of

creating, operating and growing a new business• Small Business Owner

– A person who independently owns a business that has relatively little impact in its market


Intrapreneur

People who exhibit entrepreneurial characteristics and create something new within an existing firm or organization are called intrapreneurs .

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Businesses in Canada by size

A. 97.8 percent of all businesses In Canada are small (they have fewer than 1 00 employees), and more than half of them have fewer than 5 employees

B. Medium-sized businesses: (100-499 employees) comprise 1.9 percent of employer businesses.

C. Large businesses (those with 500 or more employees) represent just 0.3 percent

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New Ventures in Canada New firms are not only the main source of job

creation, they are also responsible for the vast majority of new products and services.

In 2007, small business created 100000 jobs in Canada; this represented 40 percent of all jobs that were created that year.

Between 2002 and 2006, approximately 130000 new small businesses were started each year in Canada.

During that same period, an equal number of small businesses ceased operations each year

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women entrepreneurs in Canada

A. More and more women are starting their own small businesses; women now account for half of all new businesses that are formed.

B. According to a recent Statistics Canada report, there are about 877 000 women entrepreneurs in Canada

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The Entrepreneurial ProcessIdentifying Opportunities:A. Idea Generation: Typically, generating ideas

involves abandoning traditional assumptions about how things work and how they ought to be, and seeing what others do not. Thinking outside the box.

B. Screening Entrepreneurs often generate many ideas, and screening them is a key part of the entrepreneurial process.

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Characteristics of good ideas1. The Idea Creates or Adds Value for the Customer:

solves a significant problem2. The Idea Provides a Competitive Advantage That

Can Be Sustained:3. The Idea Is Marketable and Financially Viable:

enough customer.4. The Idea Has Low Exit Costs: can be shut down

without a significant loss.

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The Entrepreneurial ProcessA. Developing the OpportunityB. New ventures use one or more of three main

entry strategies: C. They introduce a totally new product or

service; they introduce a product or service that will compete directly with existing competitive offerings but adds a new twist (customization of the standard product); or they franchise.

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The Entrepreneurial ProcessCollateral= loan security/guaranteeFinancial Resources, Source of fund:1. Personal savings2. Love money. This type of financing includes

investments from friends3. Private investors: usually entrepreneurs.4. Venture capitalists: professionally managed

pools of Investor money5. Financial Institutions

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The Entrepreneurial ProcessCollateral= loan security/guaranteeFinancial Resources, Source of fund:

1. Suppliers. This Is referred to as trade credit from supplier, receive goods today and pay later.

2. Incubator: consulting services, legal advice, accounting services ..

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The Entrepreneur- Opportunity Fit

A. The first assessment of fit is between the entrepreneur and the opportunity.

B. The entrepreneur needs to decide whether the opportunity is something he or she can do and wants to do. A realistic self-assessment is important.

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The entrepreneurial process in a new venture context.

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Entrepreneurial Characteristics• Successful Entrepreneurs:

1. Are resourceful.2. Are concerned about good customer

relations.3. Desire to be their own boss (self-employed).4. Can deal with uncertainty and risk.5. Are open-minded.6. Rely on networks, business plans, and

consensus.7. Have different views on how to succeed, to

automate a business, and when to rely on experience or business acumen/wisdom.


Starting and Operating a New Business• The first step: Crafting a Business Plan

– Business Plan: Conveys a description of the business strategy for the new venture and how it will be implemented

– A business plan should address:• The entrepreneur’s goals and objectives• The strategies that will be used to obtain

them• The implementation of the chosen

strategies


Starting and Operating a New Business

• How do we prepare a business plan?–Setting goals and objectives–Sales forecasting–Financial planning: prepare budget,

financial statements, financial analysis.


Methods of Starting the Small Business1. Buying an Existing Business

– Less risk in purchasing ongoing, viable businessAbout one third of all new businesses that were started

in the past decade were bought from someone else.A. Advantages: 1. Increases the likelihood of success;2. it has already proven its ability to attract customers

and has established relationships with lenders, suppliers, and other stakeholders.

3. The track record.4. Real Picture of what to expect than estimate.© 2009 Pearson Education, Inc.

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Methods of Starting the Small Business1. Franchising: A franchising agreement outlines the duties and

responsibilities of each party. It stipulates the amount and type of payment that franchisees must make to the franchiser. E.g., McDonald's, Pizza.

A. payment to the franchiser ranging from 2 to 30 percent of the franchisee's annual revenues or profits.

B. The franchisee may also pay an advertising fee to the franchiser. Franchise fees vary widely, e.g., $1 million for a Burger King franchise.


Methods of Starting the Small Business1. Franchising

– Advantages• Proven business opportunity for franchisee• Access to management expertise of franchisor

– Disadvantages• Start-up costs for franchise purchase• Ongoing payments to the franchisor• Management rules and restrictions on the

franchisee


Starting the Small Business (cont’d)• Starting from Scratch

– Disadvantage: Higher risk of business failure– Advantage: Avoids problems of an existing business

• Questions to Be Answered:1.Who and where are my customers?2.How much will those customers pay for my

product?3.How much of my product can I expect to sell?4.Who are my competitors?5.Why will customers buy my product rather than the

product of my competitors?© 2009 Pearson Education, Inc.

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Exercise

What is the first thing you need in order to obtain most of these types of financing?

A business plan!

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Trends in Small-Business Startups

Emergence of Emergence of E-commerceE-commerce

Crossovers fromCrossovers fromBig BusinessBig Business

Opportunities for Opportunities for Minorities & WomenMinorities & Women

GlobalGlobalOpportunitiesOpportunities

BetterBetterSurvival RatesSurvival Rates


Five largest growth trends for new small business startups

The first is the emergence of e-commerce. The Internet provides new ways of doing business, and entrepreneurs are jumping on board. Internet sales have increased from $55.7 billion in 2003 to $125.1 billion in 2007.

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Crossovers from big business is another big trend.

Our text offers the example of John Chambers who turned Cisco into a huge Internet connectivity firm, after first spending years working for IBM and Wang.

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Opportunities for minorities and women within the small business market have grown rapidly. For example, African American small business owners own 1.2 million small businesses, an increase of 48% over the last five years. Hispanic American small business owners own 1.6 million small businesses, an increase of 31% over the last five years. Asian American small business ownership has grown 24%

Nearly 11 million small businesses are now owned by women.

All together, these businesses generate $2.5 trillion in revenues each year.

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Women cited a number of reasons for starting their own small business. Let’s review them:

• 46% of the women started their own business to better control their own schedule.

• 24% of the women saw a market opportunity and decided to pursue it.

• 23% of the women were frustrated by the “glass ceiling” in wages at big companies.

• And the remaining 7% cited other reasons.

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Global opportunities represent another new market for small business owners, such as software development companies, consulting firms and higher education.

44% of small businesses will succeed and remain in operation after 4 years, offering better survival rates than in the 1970s when nearly half of all new businesses failed.

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How about in Palestine?A. More than 98% percent of all businesses are small,

they employ 10 persons or less.B. Why the businesses in Palestine are dominated by

small ones?1. Individualism trend.2. Family oriented.3. Lack of availability of fund.4. Lack of awareness of the process of establishing

corporations.5. The skills needed to set and manage large

companies are not there.6. The Israeli occupation’s policies.7. Lack of government support.

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The Labor Force Reflects the Importance of Small Business

Over 86% of U.S. businesses have no more than 20 employees. The total number of people employed by these small businesses is about 25% of the entire U.S. workforce. Another 29% of the workforce is employed by businesses with fewer than 100 employees.

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Success and Failure in new ventures

• Ultimately, 63% of all new businesses fail in US.

• Each year 600,000 and 650,000 new businesses are launched in US. 500,000 to 600,000 are failed.

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Reasons for failure1. Poor management: it is not enough to know a

common sense about business, they must have the basic business principles. How make a proper decisions.

2. Neglect: Starting a new business requires an overwhelming time commitment. Doing it “on the side” usually isn’t enough.

3. Weak control systems: Without control systems, small business owners don’t know about problems until it’s too late.

4. Insufficient capital: Many experts recommend that a new business should have enough capital to last six months to one year without earning a profit.

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Reasons for success• Hard work, drive, and dedication: Commitment is essential.

Nearly 44% of successful entrepreneurs interviewed by the Ontario Department of Industry and Commerce cited determination as the personal quality that contributed to success.

• Market demand: Clearly, if there is demand for a product, success will be easier.

• Managerial competence: Training and experience make a real difference. Most successful entrepreneurs spend time working in successful companies or they partner with others who bring more expertise.

Luck: Never underestimate the importance of luck, but keep in mind Thomas Jefferson’s saying: “The harder I work, the luckier I become”!. Example, McAfee made a significant profit once Microsoft announced that it is entering the security business. 43

Business Ownership• Forms of Legal Ownership

– Sole proprietorship: Owned and operated by one person

– Partnership: Sole proprietorship multiplied by the number of partner-owners

– Corporation

• Choice of Ownership Form– Based on the entrepreneur’s needs/desires for

control, ownership participation, financing sources, and appropriateness of the chosen form for the industry in which the firm will compete


Sole Proprietorships

Advantages:

• Freedom

• Simple to form

• Low start up costs

• Tax benefits

Disadvantages:

• Unlimited LiabilityLimited resources

Limited fundraising capability

Lack of continuity

Unlimited Liability

Legal principle holding owners responsible for paying off all debts of a business

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Sole proprietorships\ tradersA. Sole proprietorships are the most basic legal form of

business organization.B. Advantages:

A. Freedom: Sole proprietors answer to no one but themselves—this is a terrific fit for certain personalities (and we can probably all think of someone who fits the profile!).

B. Simple to form: In some states, forming a business is as simple as hanging a sign on the door.

C. Low start-up costs: Low costs go hand-in-hand with minimal legal requirements

D. Tax benefits: Sole proprietors are taxed only on personal income, and can take advantage of certain tax deductions.

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Sole proprietorships\ traders

A. Sole proprietorships are the most basic legal form of business organization.

B. Disadvantages:A. Unlimited liability: Sole proprietors are personally liable

for all debts incurred by the company (including damages in lawsuits/claims). This is the most significant drawback to this form of business.

B. Limited resources: This can ultimately limit the size of the business.

C. Limited fundraising capability: Sole proprietors often find it difficult to borrow money. Difficult to provide loan security.

D. Lack of continuity: A sole proprietorship legally dissolves when the owner dies. 47

Partnerships

Advantages:

• More talent and money

• More fundraising capability

• Relatively easy to form

• Tax benefits

Disadvantages:

• Unlimited LiabilityDisagreements among partners

Lack of continuity

Unlimited Liability

Legal principle holding owners responsible for paying off all debts of a business

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PartnershipsA. The most common type of partnership, a general

partnership, is simply a sole proprietorship multiplied by the number of partner-owners.

A. Advantages:B. More talent and money: A partnership draws on

the talent and money of more than one person.C. More fundraising capability: Partnerships are able

to borrow money more easily from lending institutions, and also have the option of inviting more partners to invest.

D. Relatively easy to form: Legal requirements are limited, but must include a partnership agreement of some kind.

E. Tax benefits: Partners are taxed only on personal income.

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PartnershipsA. Disadvantages:1. Unlimited liability: Each partner is liable for all

debts incurred in the name of the partnership, even if one partner incurs a debt without the knowledge of the other partners.

2. Disagreements among partners: Partnerships have been known to ruin relationships between close friends and family members.

A. Discussion: What are some possible safeguards against this happening?

B. (Possibilities: Creating a fair, complete partnership, planning up front for all the contingencies you can think of, developing a fair exit agreement at the outset of the partnership.)

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Partnerships

1. Lack of continuity: When one partner leaves or dies, the original partnership dissolves, and must be reorganized if other partners want to continue.

2. Within a partnership, a significant level of conflict can be healthy and creative, generating more effective solutions to a range of different obstacles. However, an exit plan is still crucial in case disagreements become unmanageable.

A. Discussion: What should be included in the exit plan for a partnership?

(Possibilities: How to dispose of and distribute assets, how to reorganize should one or more partners exit.)

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Alternatives to General Partnerships

• Limited Partnership– Allows for limited partners who invest money but are

liable for debts only to the extent of their investments– Must have at least one general (or active) partner, who is

usually the person who runs the business and is responsible for its survival and growth

• Master Limited Partnership (agreement)– Organization sells shares (partnership interests) to

investors on public exchange. Investors are paid back from profits

– The master partner retains at least 50 percent ownership and runs the business, while minority partners have no management voice


Cooperatives• Combine the freedom of sole

proprietorships with the financial power of corporations

• Groups of sole proprietorships or partnerships agree to work together for their common benefit.

• It is formed to benefit its owners in the form of reduced prices and/or the distribution of surpluses at yearend.

© 2009 Pearson Education, Inc. 53

What is a Corporation?

““An artificial being, invisible, intangible, and existing An artificial being, invisible, intangible, and existing only in contemplation\ reflection of the law.” only in contemplation\ reflection of the law.”

Corporations– Firms that have filed papers of incorporation. – There are 4.93 million corporations in the U.S. that

account for 20% of all U.S. businesses, but generate 85% of all revenue.

• Corporations may:1.Be small or large2.Sue and be sued3.Buy, hold, and sell property4.Make and sell products5.Commit crimes and be tried and punished for them6.Have limited liability for individuals who form them


Discussion

A. : guess the largest Palestinian companies.

A. Examples: PALTEL, PADECO, Bank of Palestine, Alawda.

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Corporations

• Advantages:– Limited liability: The

owners’ responsibility for the debts of a business is limited to their investment in a business

– Continuity– Stronger fundraising

capability

• Disadvantages:– Double taxation of

dividends– Fluid control– Complicated and

expensive to form


Corporation

Advantages:1. Limited liability: The liability of investors

(owners) for the debts of a corporation is limited to the size of their investments—a huge benefit!

2. Continuity: Theoretically, a corporation may continue to exist forever, with ownership transferred via sale of stock.

3. Stronger fund-raising capability: Lenders are more willing to grant loans. Larger corporations also have the option of selling stock to raise capital.

CorporationDisadvantages1. Double taxation: Profits earned by corporations are

taxed at the corporate level, and then taxed again at the ownership level. Is it fair? Who benefits?

2. Fluid \difficult control: Given the easy transfer of ownership, corporations are subject to hostile takeovers, which (at the very least) distract/divert management from achieving the corporation’s goals. El-Fayed took over Harrots.

3. Complicated and expensive to form: Costs include filing fees to meet government incorporation requirements, and usually legal fees as well. (e.g., must register to: ministry of Justice, chamber of commerce, ministry of economics, local authority).

Types of Corporations• Closely Held (Private) Corporation: stock

is held by few people, not available to public.

• Publicly Held (Public) Corporation: shares are publically issued.


Types of Corporations• Limited Liability Corporation (LLC). This is a

popular form of incorporation because owners are taxed like partners but have the limited liability of a corporation.

• Professional Corporation. These are usually doctors, lawyers, etc. Their corporate status provides limited liability, but an individual’s negligent performance can make an individual within the firm personally liable.

• Multinational (Transnational) Corporation© 2009 Pearson Education, Inc. 61

Comparative Summary: Three Forms of Business

Business Form Liability Continuity ManagementInvestment

Sources

Personal, unlimited

Ends with death or decision of owner

Personal, unrestricted

Personal

Personal, unlimited

Ends with death or decision of any partner

Unrestricted or depends on partnership agreement

Personal by partner(s)

Capital invested

As stated in charter, perpetual/ continue or for specified period of years

Under control of board of directors, which is selected by stockholders

Purchase of stock

Proprietorship

General Partnership

Corporation

Copyright ©2003 Prentice Hall, Inc.Copyright ©2003 Prentice Hall, Inc. 4 - 4 - 6262

Managing a Corporation• Corporate Governance

– The roles of shareholders, directors, and other managers in corporate decision making and accountability

– Corporate governance is established by the firm’s bylaws and involves three bodies:• Stockholders (shareholders): Investors who buy

ownership shares in the form of stock• The board of directors: Group elected by

stockholders to oversee corporate management• Corporate officers: Top managers hired by the

board to run the corporation© 2009 Pearson Education, Inc. 63

Stockholders: Owners of Corporations

• Stock: A share of ownership in a corporation• Dividends: Profits distributed among stockholders


Types of Stocks:

1. Common Stock: The most basic form of ownership. Common stockholders always have voting rights.

2. Preferred Stock: Offers fixed dividends but no corporate voting rights.A. Discussion: How many of you own stock? Which

companies? Why?

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Special Issues in Corporate Ownership

• Joint Ventures and Strategic Alliances:– Strategic alliance: Two or more organizations collaborate

on a project for mutual gain– Joint venture: the collaboration of two or more

organizations on a project for mutual gain. Partners share ownership of a new enterprise.

• Employee Stock Ownership Plans– Allows employees to own a share of the corporation

through trusts established on their behalf• Institutional Investors

– Control enormous resources and can buy huge blocks of stock


Special Issues in Corporate Ownership (cont’d)

• Mergers, Acquisitions, Divestitures, and Spin-Offs:– Merger: Two firms combine to create a new

company– Acquisition: One firm buys another outright– Divestiture: Strategy whereby a firm sells one or

more of its business units– Spin-off: A firm sells part of itself to raise capital


Review

A. From the standpoint of the franchisee, what are the primary advantages and disadvantages of most franchise arrangements?

Advantages: proven business opportunity, access to management expertise

Disadvantages: high start-up costs, possible on-going fees, management rules and restrictions

Review

Why might a closely held corporation choose to remain private? Why might a closely held corporation choose to become a publicly traded corporation?

A. Remain private: to retain controlB. Become public: to generate

additional funding

Homework

Answer questions (1-6) page 108.

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Documents

CHAPTER 4: Entrepreneurship, Small Business, and New Venture Creation 1