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.

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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

I. What Is a “Small” Business?

A. The Importance of Small Business in the U.S. Economy
1. Job Creation
2. Innovation
3. Importance to Big Business
B. Popular Areas of Small-Business Enterprise
1. Services
2. Construction
3. Finance and Insurance
4. Wholesaling
5. Transportation and Manufacturing

II. Entrepreneurship
A. Distinctions Between Entrepreneurship and Small
Business
B. Entrepreneurial Characteristics

III. Starting and Operating the Small Business

A. Crafting a Business Plan
1. Setting Goals and Objectives
2. Revenue Forecasting
3. Financial Planning
B. Starting the Small Business
1. Buying an Existing Business

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 2. Starting From Scratch
C. Financing the Small Business
1. Other Sources of Investment
2. SBA Financial Programs
3. Other SBA Programs

IV. Franchising: Advantages and Disadvantages of Franchising

V. Success and Failure in Small Business

A. Trends in Small-Business Start-Ups
1. Emergence of E-Commerce
2. Crossovers From Big Business
3. Opportunities for Minorities and Women
4. Global Opportunities
5. Better Survival Rates
B. Reasons for Failure
1. Managerial Incompetence
2. Neglect

3. Weak Control Systems

4. Insufficient Capital
C. Reasons for Success
1. Hard Work, Drive, and Dedication
2. Market Demand
3. Managerial Competence
4. Luck

VI. Noncorporate Business Ownership

A. Sole Proprietorships
1. Advantages of Sole Proprietorships
2. Disadvantages of Sole Proprietorships
B. Partnerships
1. Advantages of Partnerships
2. Disadvantages of Partnerships

VII. Corporations
A. The Corporate Entity
1. Advantages of Incorporation
2. Disadvantages of Incorporation
B. Types of Corporations
C. Managing a Corporation
1. Corporate Governance
2. Stock Ownership and Stockholders’ Rights
3. Boards of Directors
4. Officers
D. Special Issues in Corporate Ownership

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 1. Joint Ventures and Strategic Alliances
2. Employee Stock Ownership Plans
3. Institutional Ownership
4. Mergers, Acquisitions, Divestitures, and Spin-Offs

LECTURE OUTLINE

I. 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.

A. 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.

1. 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.

2. Innovation. Small business supplied 55 percent of all

innovations that reach the U.S. marketplace.

3. Importance to Big Business. Most products made by

big businesses are sold to consumers by small ones.

B. Popular Areas of Small-Business Enterprise (Use PowerPoint

3.6.)

Major small-business industry groups include the following:

1. Services. This is the fastest-growing segment of small

business.

2. Construction. About 10 percent of businesses with

fewer than 20 employees are involved in construction.

3. Finance and Insurance. These firms account for about

10 percent of all firms with fewer than 20 employees.

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

5. Transportation and Manufacturing.

Notes:
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II. Entrepreneurship (Use PowerPoint 3.7.)

Entrepreneurship, as defined in Chapter 1, is an essential part of a

few-enterprise system.

A. 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.

B. 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:
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III. 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.

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A. Crafting a Business Plan

A business plan summarizes business strategy for the new venture

and shows how it will be implemented.

1. 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.

2. 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.

3. Financial Planning. This is the entrepreneur’s plan for

turning all activities into dollars.

B. Starting the Small Business (Use PowerPoint 3.9.)

Small-business people begin by understanding the true nature of

their businesses.

1. 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.

2. 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.

C. 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.

1. Other Sources of Investment. Venture capital

companies are groups of investors seeking to profit on
companies with growth potential; money is invested in

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 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.

2. 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.

3. Other SBA Programs. Aside from its financing role, the

SBA offers management counseling programs at virtually
no cost.

Notes:
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IV. 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.

A. 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:
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V. Success and Failure in Small Business

A. 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.

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

2. Crossovers from Big Business. Many businesses are

started by individuals who leave positions in large
corporations to put their experience to work for
themselves.

3. Opportunities for Women and Minorities. The number

of businesses started by minorities and women is growing
rapidly.

4. Global Opportunities. Many entrepreneurs are finding

business opportunities throughout the world.

5. 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.

B. Reasons for Failure (Use PowerPoint 3.13.)

Four general factors contribute to small-business failure.

1. Managerial Incompetence

2. Neglect

3. Weak control Systems

4. Insufficient Capital

C. Reasons for Success (Use PowerPoint 3.13.)

Four general factors contribute to small-business success.

1. Hard Work, Drive, and Dedication

2. Market Demand

3. Managerial Competence

4. Luck

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Notes:
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VI. Noncorporate Business Ownership (Use PowerPoint 3.14.)

A. 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.

1. Advantages of Sole Proprietorships. Freedom, ease in

forming, low start-up costs, and tax benefits are the
advantages of this form of ownership.

2. 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.

B. Partnerships (Use PowerPoint 3.16.)

A general partnership, the most common type, is a sole

proprietorship multiplied by the number of partner-owners.

1. 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.

2. 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:
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VII. 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.

A. 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.

1. Advantages of Incorporation. These include limited

liability, continuity, and the ability to raise money.

2. 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.

B. 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.

C. 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.

1. Corporate Governance. Defined by the firm’s bylaws,

corporate governance involves stockholders, the board
of directors, and corporate officers.

2. Stock Ownership and Stockholders’ Rights.

Stockholders are the owners of a corporation. Preferred
stock guarantees holders fixed dividends and gives

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 preference over common stockholders in dividend
distribution; common stock pays dividends only if the
company makes a profit. Common stockholders have
voting rights.

3. Boards of Directors. The board of directors is the

governing body of the corporation.

4. 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.

D. Special Issues in Corporate Ownership (Use PowerPoint 3.22,

3.23.)

1. 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.

2. Employee Stock Ownership Plans (ESOPs). ESOPs

are trusts established on behalf of the employees.

3. Institutional Ownership. Institutional investors include

mutual funds and pensions that buy enormous blocks of
stock.

4. 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:
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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.

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 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.

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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?

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  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.

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