Understanding Entrepreneurship and Business Ownership

Chapter 3

Understanding Entrepreneurship and Business Ownership

Chapter Overview

A small business is independently owned and managed and does not dominate its market.  Small businesses are crucial to the economy because they create new jobs, foster entrepreneurship and innovation, and supply goods and services needed by larger businesses.  Services are the easiest businesses to start, followed by retailing, wholesaling, construction, finance, and insurance.  Transportation and manufacturing include the fewest small firms because these segments are so resource intensive.

Sole proprietorships consist of one person doing business.  While they offer freedom, privacy, and tax benefits, they can be hindered by limited access to talent and capital, and lack of continuity.  Furthermore, sole proprietors are subject to unlimited liability:  they are personally liable for all debts incurred by the business.  Partnerships are proprietorships with multiple owners.  They share many of the disadvantages of sole proprietorships, but they typically have easier access to talent and capital.

Corporations are independent legal entities that offer continuity, significant opportunities for raising money, and limited liability for the owners (their liability is limited to their investments).  However, unlike other forms of business, corporations are subject to double taxation:  In addition to paying taxes on profits at the corporate level, individual investors must pay taxes on earned income distributed to them via dividends.

Franchising has become a popular form of small-business ownership because the franchiser (parent company) supplies financial, managerial, and marketing expertise to the franchisee, which buys the right to sell the franchiser’s product.  Although franchising is less risky than starting a new business from scratch, start-up costs can be high, and the franchisee is typically subject to rules and regulations regarding management of the business.

One of the first choices an entrepreneur must make is whether to buy an existing business or to start a business from scratch.  A successful existing business has working relationships with other businesses, and has proven its ability to generate profit.  While brand new businesses are more risky, they allow their owners to plan and work with a clean slate.  Most entrepreneurs rely heavily on their own resources for financing, but may also receive financial aid from lending institutions, venture capital firms, or the Small Business Administration.

 

Chapter Objectives

1. Define small business, discuss its importance to the U.S. economy, and explain which types of small businesses best lend themselves to success.
2. Explain entrepreneurship and describe some key characteristics of entrepreneurial personalities and activities.
3. Describe the business plan and the start-up decisions made by small businesses and identify sources of financial aid available to such enterprise.
4. Explain the main reasons why new business start-ups are increasing and identify the main reasons for success and failure in small business.
5. Explain sole proprietorships and partnerships and discuss the advantages and disadvantages of each.
6. Describe corporations, discuss their advantages and disadvantages, and identify different kinds of corporations.
7. Explain the basic issues involved in creating and managing a corporation and identify recent trends and issues in corporate ownership.

 

REFERENCE OUTLINE

Opening Case:  The Competitor From Out of the Blue

• What Is a “Small” Business?
• The Importance of Small Business in the U.S. Economy
• Job Creation
• Innovation
• Importance to Big Business
• Popular Areas of Small-Business Enterprise
• Services
• Construction
• Finance and Insurance
• Wholesaling
• Transportation and Manufacturing

 

• Entrepreneurship
• Distinctions Between Entrepreneurship and Small Business
• Entrepreneurial Characteristics

• Starting and Operating the Small Business
• Crafting a Business Plan
• Setting Goals and Objectives
• Revenue Forecasting
• Financial Planning
• Starting the Small Business
• Buying an Existing Business
• Starting From Scratch
• Financing the Small Business
• Other Sources of Investment
• SBA Financial Programs
• Other SBA Programs

 

• Franchising:  Advantages and Disadvantages of Franchising

• Success and Failure in Small Business
• Trends in Small-Business Start-Ups
• Emergence of E-Commerce
• Crossovers From Big Business
• Opportunities for Minorities and Women
• Global Opportunities
• Better Survival Rates
• Reasons for Failure
• Managerial Incompetence
• Neglect

 

• Weak Control Systems
• Insufficient Capital
• Reasons for Success
• Hard Work, Drive, and Dedication
• Market Demand
• Managerial Competence
• Luck

• Noncorporate Business Ownership
• Sole Proprietorships
• Advantages of Sole Proprietorships
• Disadvantages of Sole Proprietorships
• Partnerships
• Advantages of Partnerships
• Disadvantages of Partnerships

 

• Corporations
• The Corporate Entity
• Advantages of Incorporation
• Disadvantages of Incorporation
• Types of Corporations
• Managing a Corporation
• Corporate Governance
• Stock Ownership and Stockholders’ Rights
• Boards of Directors
• Officers
• Special Issues in Corporate Ownership
• Joint Ventures and Strategic Alliances
• Employee Stock Ownership Plans
• Institutional Ownership
• Mergers, Acquisitions, Divestitures, and Spin-Offs

LECTURE OUTLINE

• What Is a “Small” Business?  (Use PowerPoint 3.3.)

 

A small business is one that is independently owned and managed and does not dominate its market.

• The Importance of Small Business in the U.S. Economy  (Use PowerPoint 3.4, 3.5.)

 

Most U.S. businesses employ fewer than 100 people, and most U.S. workers are employed by small firms.  The contribution of small business can be measured through its impact on job creation, innovation, and its importance to big business.

• Job Creation.  Small businesses are an important source of new jobs; in recent years, small businesses have accounted for 38 percent of all new jobs in high-technology sectors of the economy alone.

 

• Innovation.  Small business supplied 55 percent of all innovations that reach the U.S. marketplace.

• Importance to Big Business.  Most products made by big businesses are sold to consumers by small ones.

 

• Popular Areas of Small-Business Enterprise  (Use PowerPoint 3.6.)

Major small-business industry groups include the following:

• Services.  This is the fastest-growing segment of small business.

 

• Construction.  About 10 percent of businesses with fewer than 20 employees are involved in construction.

• Finance and Insurance.  These firms account for about 10 percent of all firms with fewer than 20 employees.

 

• Wholesaling.  Wholesalers buy products from manufacturers and sell them to retailers; wholesalers are the middlemen.

• Transportation and Manufacturing.

 

Notes: ______________________________________________________________________________________________________________________________________________________________________________________________________

• Entrepreneurship  (Use PowerPoint 3.7.)

 

Entrepreneurship, as defined in Chapter 1, is an essential part of a few-enterprise system.

• Distinctions Between Entrepreneurship and Small Business  (Use PowerPoint 3.8.)

 

Many similarities exist between small business and entrepreneurship; however, entrepreneurs are the risk-takers who start a business with the goal of growth and expansion.

• Entrepreneurial Characteristics

 

Successful entrepreneurs are often distinguished from others through a set of characteristics, including resourcefulness, concern for customer relations, a desire for autonomy, the ability to handle ambiguity, a desire for risk-taking, a need for personal freedom, and the opportunity for creative expression.

Notes:  ______________________________________________________________________________________________________________________________________________________________________________________________________

• Starting and Operating the Small Business

 

Entrepreneurs must make a number of decisions when they start their business.  They must decide whether to buy an existing business or to start from scratch.  In addition, they must determine sources of financing needed and when to seek advice from others.  Another integral part of starting a small business is a well-crafted business plan.

 

• Crafting a Business Plan

 

A business plan summarizes business strategy for the new venture and shows how it will be implemented.

• Setting Goals and Objectives.  A business plan should discuss the entrepreneur’s goals and objectives, the strategies used to obtain them, and how these strategies will be implemented.

 

• Revenue Forecasting.  The revenue forecast requires that the entrepreneur demonstrate an understanding of the market, the strengths and weaknesses of existing firms, and the means by which the new venture will compete.

 

• Financial Planning.  This is the entrepreneur’s plan for turning all activities into dollars.

• Starting the Small Business  (Use PowerPoint 3.9.)

 

Small-business people begin by understanding the true nature of their businesses.

• Buying an Existing Business.  Existing businesses have already proved their ability to attract consumers and to establish rapport with lenders, buyers and suppliers, and the community.  Most consultants recommend that entrepreneurs buy existing businesses because the odds of success are greater.

 

• Starting From Scratch.  Risks with this approach are greater than with buying an existing business.  Starting from scratch allows the entrepreneur to operate without the commitments, policies, errors, etc. of a predecessor.

• Financing the Small Business  (Use PowerPoint 3.10.)

 

Many sources for business financing are available.  Personal resources account for more than two-thirds of all money invested; smaller portions of funding come from banks, independent investors, and government loans.

• Other Sources of Investment.  Venture capital companies are groups of investors seeking to profit on companies with growth potential; money is invested in return for partial ownership.  Small business investment companies are licensed to borrow money from the SBA and invest it in or loan it to small businesses.

 

• SBA Financial Programs.  Under the SBA’s guaranteed loans program, small businesses may borrow from commercial lenders with the SBA guaranteeing to repay 75-85 percent of the loan up to $750,000.  Under the immediate participation loans program, the SBA and the bank contribute a share of the money, with the SBA’s share not exceeding $150,000.

• Other SBA Programs.  Aside from its financing role, the SBA offers management counseling programs at virtually no cost.

 

Notes:  ______________________________________________________________________________________________________________________________________________________________________________________________________

• Franchising  (Use PowerPoint 3.11.)

 

A franchise is an arrangement in which a franchiser (seller) permits a franchisee (buyer) to sell the franchiser’s products.

• Advantages and Disadvantages of Franchising

 

Franchisers benefit from the ability to grow by using investment money from franchisees.  Franchisees benefit from the access they have to big-business management skills; franchisees, on the other hand, are plagued by high start-up fees, and obligations to contribute percentages of sales to parent corporations.

Notes:  ______________________________________________________________________________________________________________________________________________________________________________________________________

• Success and Failure in Small Business

 

• Trends in Small-Business Start-Ups  (Use PowerPoint 3.12.)

Several factors account for the thousands of new business start-ups in the United States each year.

• Emergence of E-Commerce.  The rapid emergence of electronic commerce is the most significant recent trend.

 

• Crossovers from Big Business.  Many businesses are started by individuals who leave positions in large corporations to put their experience to work for themselves.

• Opportunities for Women and Minorities.  The number of businesses started by minorities and women is growing rapidly.

 

• Global Opportunities.  Many entrepreneurs are finding business opportunities throughout the world.

• Better Survival Rates.  New businesses now have a better chance of survival than ever before; the SBA estimates that at least 40 percent of all new businesses can expect to survive for six years.

 

• Reasons for Failure  (Use PowerPoint 3.13.)

Four general factors contribute to small-business failure.

• Managerial Incompetence

 

• Neglect

• Weak control Systems

 

• Insufficient Capital

 

• Reasons for Success  (Use PowerPoint 3.13.)

Four general factors contribute to small-business success.

• Hard Work, Drive, and Dedication

 

• Market Demand

• Managerial Competence

 

• Luck

Notes:  ______________________________________________________________________________________________________________________________________________________________________________________________________

• Noncorporate Business Ownership  (Use PowerPoint 3.14.)

 

• Sole Proprietorships  (Use PowerPoint 3.15.)

A sole proprietorship is owned and usually operated by one person; about 73 percent of all U.S. businesses are sole proprietorships.

• Advantages of Sole Proprietorships.  Freedom, ease in forming, low start-up costs, and tax benefits are the advantages of this form of ownership.

 

• Disadvantages of Sole Proprietorships.  Unlimited liability, lack of continuity, and a possible lack of resources of a single individual are the major drawbacks of this form of organization.

• Partnerships  (Use PowerPoint 3.16.)

 

A general partnership, the most common type, is a sole proprietorship multiplied by the number of partner-owners.

• Advantages of Partnerships.  The ability to grow with the addition of new talent and money, few legal requirements, and tax advantages are benefits of this form of ownership.

 

• Disadvantages of Partnerships.  Unlimited liability in that each partner may be liable for the debts incurred in the name of the partnership, lack of continuity, difficulty of transferring ownership, and little or no guidance for conflict resolution are the major drawbacks of this form of ownership.

Notes:  ______________________________________________________________________________________________________________________________________________________________________________________________________

 

• Corporations  (Use PowerPoint 3.17.)

 

Both large and small corporations account for 20 percent of all businesses but generate about 89 percent of all sales revenues in the United States.

• The Corporate Entity  (Use PowerPoint 3.18.)

 

Characteristics of corporations include legal status as separate entities, property rights and obligations, and indefinite life spans.  Corporations may sue and be sued; buy, hold, and sell property; make and sell products to consumers; commit crimes and be tried and punished for them.

• Advantages of Incorporation.  These include limited liability, continuity, and the ability to raise money. 

 

• Disadvantages of Incorporation.  Difficulty in ease of transferring ownership, control, and cost are drawbacks of incorporation.  In addition, double taxation plagues a corporation since a regular corporation must pay income taxes on profits and stockholders must pay taxes on income returned by their investments.

• Types of Corporations  (Use PowerPoint 3.19.)

 

Stock is held by only a few people and is not available for sale to the public in a private corporation.  The S corporation is a hybrid of a private corporation and partnership.  In a limited liability corporation, owners are taxed like partners with each paying personal taxes only.  A multinational corporation spans national boundaries.

• Managing a Corporation  (Use PowerPoint 3.20, 3.21.)

 

Once the corporate entity comes into existence, it must be managed by people who understand the principles of corporate governance.

• Corporate Governance.  Defined by the firm’s bylaws, corporate governance involves stockholders, the board of directors, and corporate officers.

 

• Stock Ownership and Stockholders’ Rights.  Stockholders are the owners of a corporation.  Preferred stock guarantees holders fixed dividends and gives preference over common stockholders in dividend distribution; common stock pays dividends only if the company makes a profit.  Common stockholders have voting rights.

• Boards of Directors.  The board of directors is the governing body of the corporation.

 

• Officers.  Appointed by the board of directors, officers oversee the day-to-day operations of the corporation.  The chief executive officer, or CEO, oversees overall operations.

• Special Issues in Corporate Ownership  (Use PowerPoint 3.22, 3.23.)

 

• Joint Venture and Strategic Alliances.  In a strategic alliance, two or more organizations collaborate on a project for mutual gain; when partners share ownership of what is essentially a new enterprise, it is called a joint venture.

• Employee Stock Ownership Plans (ESOPs).  ESOPs are trusts established on behalf of the employees.

 

• Institutional Ownership.  Institutional investors include mutual funds and pensions that buy enormous blocks of stock.

• Mergers, Acquisitions, Divestitures, and Spin-Offs.  A merger occurs when two firms combine to create a new company; in an acquisition, one firm buys another outright.  A divestiture occurs when a firm sells off unrelated and/or underperforming businesses.  When a firm sells part of itself to raise capital, the strategy is known as a spin-off.

 

Notes:  ______________________________________________________________________________________________________________________________________________________________________________________________________

 

 

Answers to Questions and Exercises

Questions for Review

1. Why are small businesses important to the U.S. economy?

 

Small businesses create new jobs, foster entrepreneurship and innovation, and supply goods and services needed by larger businesses.

2. What is the difference between a small-business owner and an entrepreneur?

 

A person may be a small-business owner only, an entrepreneur only, or both.  For example, a person who opens a small pizza parlor with no plans to grow and expand is not really an entrepreneur.  The basic distinction between small-business ownership and entrepreneurship is aspiration – the former wants to remain small and support a lifestyle whereas the latter is motivated to grow, expand, and build.

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

 

Proven business opportunity and access to management expertise are advantages.  Disadvantages include:  high start-up costs, possible on-going fees, management rules and restrictions.

4. Which industries are easiest for start-ups to enter?  Which are hardest?  Why?

 

The most difficult businesses to begin might be in the transportation, manufacturing, and construction industries.  There are numerous federal and state guidelines that govern each of these industries; in addition, firms within these industries often require high initial outlays of capital.  The easiest businesses to begin might fall within the retail sector; these businesses require little start-up capital which aids in market entry.

Questions for Analysis

5. Why might a closely held corporation choose to remain private?  Why might a closely held corporation choose to be publicly traded?

 

Such corporations may choose to remain private if control retention is the aim.  Many closely held corporations choose to become public to generate additional funding.

 

6. If you were going to open a small business, what type would it be?  Why?

Answers will vary.  Many students will choose businesses within those industries that offer ease in market entry, primarily because resource availability may be limited to most students since they may not have built much personal credit and are likely not at the peak of their income-earning capacity yet.

7. Would you prefer to buy an existing business or start from scratch?  Why?

 

Answers will vary.  Some students may find the added difficulty in starting from scratch especially challenging but preferable.  Others will likely want to benefit from an existing business.

8. Under what circumstances might it be wise for an entrepreneur to reject venture capital?  Under what circumstances might it be advisable to take more venture capital than the entrepreneur actually needs?

 

If the funding has “strings attached” that might interfere with the entrepreneur’s plans for the business, the venture capital may be turned down.  However, if the terms were especially favorable (e.g. low interest rate, long life of loan) and the entrepreneur has future plans that would use the funds effectively, the venture capital may be welcomed.

Application Exercises

9. Interview the owner-manager of a sole proprietorship or a general partnership.  What characteristics of that business form led the owner to choose it?  Does he or she ever contemplate changing the form of the business?

 

Answers will vary.

10. Identify two or three of the fastest growing businesses in the United States during the last year.  What role has entrepreneurship played in the growth of these firms?

 

With the economic downturn in recent years, many market analysts are suggesting that the economy is making a comeback.  Students will likely be able to identify a number of businesses that are appearing to enter a growth phase after being at a lull for a few years.  Answers will vary widely.

Answers to Exercising Your Ethics

1. Identify the ethical issues, if any, regarding Mark and Connie’s respective positions on Mark’s proposed $2,000 monthly salary increase.

 

One perspective is that both partners seem to be poor communicators, which is an interpersonal issue rather than an ethical issue.  They should both be discussing salary changes in the context of specific contributions.  The ethical issue regarding Mark’s position seems to be fairness.  Given his interests, skills, and experience, will he really be taking on half of Connie’s responsibilities?  The ethical issue regarding Connie’s position seems to be honesty.  Removing inventory for personal use is clearly an underhanded way of resolving her resentment toward Mark.

2. What kind of salary adjustments do you think would be fair in this situation?  Explain why.

 

Answers will vary.  However, in explaining their answers, students should consider how contributions from both partners would change.

3. There is, of course, another way for Mark and Connie to solve their differences.  Because the terms of participation have changed, it might make sense to dissolve the existing partnership.  What do you recommend in this regard?

 

Answers will vary, but dissolution is worth considering given that both parties appear to feel wronged.  Given Connie’s plan to remove inventory for personal use each month, further conflict seems inevitable.

Answers to Building Your Business Skills

1. Do you think your business would be successful on the Internet?  Why or why not? 

 

Answers will vary, but students should consider whether they could translate the success of their retail store to the Internet environment.  If so, how?

2. Based on your analysis, how will Internet expansion affect your current business practices?  What specific changes are you likely to make? 

 

Answers will vary, but students should consider the following issues:

• Who will design and maintain the site?
• How will advertising and promotion need to change?
• How will the business handle the potential increase in orders from all over the country?
• Will pricing and service policies need to change?  If so, how?
• Will the focus of the business shift to the Web site?
• How will you need to train your employees regarding the site?

 

3. Do you think operating a virtual storefront will be harder or easier than doing business in your local community?  Explain your answer.

Answers will vary.  Students will likely be able to better assess the typical reactions of their local market better than “understanding” the virtual storefront market.

Classroom Activities

1. Ask students to interview an entrepreneur.  In the interview, students should inquire about what inspired that individual to either buy an existing business or to start from scratch.  Students shall ask the entrepreneur to assess the competitive environment in which he or she operates, addressing the challenges he or she has faced along the way as well as any overall industry changes that may have become evident over time. 

 

2. Contact the Small Business Administration to invite a SCORE representative to speak with the class.  SCORE representatives are volunteer, retired executives who can share their experiences and counsel with groups of potential entrepreneurs.  Students will benefit from the insight given from individuals who have faced similar challenges as many other entrepreneurs and small-business managers.