Choosing the Type of Business in Entrepreneurship - Coursework Example

Name: Course: Tutor: Institution: City and State: Date: Introduction Choosing the type of business is the fundamental step in entrepreneurship since it acts as a guide to other functions of the business. This begins with deciding the form of business unit that best suits the operation as well as picking the sources of finance that facilitate its operations (Fontana 2010 p.133). Sole proprietorship Sole proprietorship is the simplest business unit that exists operated by one natural person (Moore 2008 p.42). It is an unincorporated business unit and therefore not a legal entity since its existence relies entirely on that of the owner. A sole proprietor is therefore a person who owns the entity, takes responsible for its transactions as well as its debts, and is entitled to all the profits of the business. Advantages: Ease of formation- sole proprietorship establishment is a quick process that requires less documents and costs cheap. Naming of the business also takes a simple perspective by allowing the owner to name the business after him or the option of giving the business a fictitious name for identification purposes. Decision-making- the owner has the sole power to make decisions regarding the business without any legal requirement to consult with other people. Disadvantages: Unlimited liability- this is the main disadvantage of operating a sole proprietorship business since it is not a separate entity from its owner. The owner is therefore liable for the debts of the business and in case the debts exceed the value of the business, he pays up from his personal assets. The owner is also liable to any unlawful dealings of the business. Limited life- the existence of the business relies on the life of the owner since the business is the same entity as the owner. The business’ life therefore ends with the death of the sole proprietor. Difficulty in raising capital- raising capital for the business depends on the credit worthiness of the owner. Partnership This is a form of business formed by two or more persons who contribute property, labor or skill with an agreed proportion of share in profits and losses. It is an unincorporated business unit with members personally liable to the partnership’s losses (Stickney & Weil 2006 p145). Advantages: Improved decision-making- presence of many members ensures consultation and diversity of ideas when making critical decisions. Ease of formation- just like the sole proprietorship, partnerships is easy to establish within a short period. Ease of access to capital- the business has a wider borrowing capacity hence the ability to access more capital in form of loans. Disadvantages: Unlimited liability- partnership members have unlimited liability hence personally liable for the business’ debts in case they exceed the value of the business. The partners’ liability is equivalent to the proportion of their share of profits and losses. Limited life- the exit or death of a partner affects the structure of the partnership. Presence of disagreements- presence of many members translates into disagreements and a derailed decision making process. Limited company This is an incorporated business unit that is a separate entity to its owners and hence recognized by the law as a legal person (Warren, Reeve & Duchac 2011 p.50). Limited companies may either be private or public limited companies. Public limited companies require a minimum of two members in its formation while private limited companies can operate with one member but cannot issue shares to the public. Advantages: Limited liability- the owners have limited liability to the company’s debts since it operates as a separate entity (Emerson 2009 p.203). Separate legal entity- the company is a separate entity to its owners and undertakes transactions in its own right. It can also be sued or sue in its own capacity. Diversity of talent- a company has the capacity to employ various employees with different skills and talents hence ensuring high performance of the entity. Ease of access to capital- the company can raise funds through issuing shares to the public among other sources of funds available for the entity. Disadvantages: Agency problem- the management team runs companies since most owners are unavailable to handle business personally. An agency problem emerges when the management seeks to protect its own interests at the expense the shareholders’ interests. Sources of Finance There are various sources of finance available for a business to finance its operations. There sources can be short term, medium term, and long term depending on the duration of repayment. A business needs to understand these sources and pick a financing mix that works best for its operations (Fredrick & Terjesen 2006 p.64). Short-Term Finances Short-term sources of finance are those payable within one year (Emerson 2009 p.61). They are easy to obtain and normally involve smaller amounts of funds and require a simple procedure of acquisition. They include: Trade credit: suppliers offer the business goods on credit that enables the business maintain its liquidity position. The firm can then use this money to generate more income for the business rather than paying bills. Overdraft: the bank may allow the business make withdrawals from its account an amount exceeding its account balance. Factoring: the firm may sell invoices to factors to receive instant funds rather than waiting for their maturity. Advances from customers: when customers pay for goods in advance, they offer the business funds for use in conducting their business. Medium Term Finances These sources of finance require repayment within a period of 3 to 5 years (Rigby 2011 38). They are a reasonable option when long-term financing is unavailable and used when the business expects to write off deferred expenditures within 3 to 5 years. Preference share capital: the firm raises this form of finance through preference shares offered to shareholders who are not real owner of the business Debentures: they are units of debt sold to investors in return for their money and the repayment includes interest. Medium term loans: financial institutions offer loans scheduled for repayment within 3 to 5 years to lower the risk of defaulting. Hire purchase: it enables the business to use equipment before paying the full amount of the selling price. It involves the payment of a deposit followed by installments payable later. Leasing: it also enables the business possess and use an equipment or property while making payments. The lease could be either operating or financial depending on the arrangement between the lessor and the lessee. In the financial lease, the lease payment equals the value of the property and the lessee owns the property upon completion of the installment. Long-Term Sources Funds raised through these sources require repayment within a period of over 5 years and can go up to 20 years. They involve large amounts of funds and require substantial collateral to offer security in case the business is unable to repay the funds. Firms use the funds to acquire equipment that require heavy investments such as machinery (Kimmel, Weygandt & Kieso 2010 p.77). They include: Equity share capital: this forms the largest source of finance for a firm contributed by the real owners of the business. It includes certain privileges such as voting rights enjoyed by the owners who make important decisions of the firm that affect its future. The repayment of the funds takes place upon dissolution of the business but the owners can trade their shares to potential buyers. Since the equity shareholders’ interest is in wealth maximization, they do not expect to get repayment for their money within a short period. Loans: financial institutions such as banks extend long-term loan to businesses meant for repayment over a long period. Considering the time factor of money, this is considerably the cheapest source of finance in terms of the interest rate and the future value of the funds. Debentures: this is a unit of debt held by the public as evidence of money owed to them by the business. It is a tool for borrowing money from the public in promise of repaying them at an agreed interest rate in future. Conclusion The choice of source of finance for the business depends on the business unit, the required amount of funds, and the cost of finance. Long-term sources involve large amounts of funds and are less expensive unlike short-term sources that charge high interest rates (Horngren, Fraser & Harisson 2009 p.89). The nature of the business unit may also limit the access to certain sources of funds due to the issue of credit worthiness. Recommendation Generally, the type of business unit that a person chooses to invest depends on the nature of the business. For high-risk businesses, a limited company is preferable to protect owners from huge debts in case of the occurrence of unfavorable events. Consider the interest rates while choosing a source of finance to minimize the cost of finance (Chandra 2008 p.123). Mixing different types of finances facilitate the operation of the business since repayment occurs at different periods hence minimal effect on the liquidity position. References Chandra P. (2008). Financial Management. Boston: Mcgraw Hill. Emeerson R. W. (2009).Business Law. New York: Spon Press. Fontana P. K. (2010). Choosing the Right Legal Form Of Business: The Complete Guide. Chichester: Wiley Publishers. Fredrick H., Terjesen S. (2006). Sources of Funding for Australia’s Enterprenuers. United Kingdom: Oxford Publishers. Horngren C. T., Fraser H. B., Harisson W. T. (2009). Financial Accounting. Chichester: Wiley Kimmel P. D., Weygandt J. J., Kieso D. E. (2010). Financial Accounting: Tools for Business Decision Making. Pearson Australia Moore C. W. (2008). Managing Small Business: An Enterprenuerial Emphasis. Boston: Mcgraw Hill. Rigby G. (2011). Types and Sources Of Finance For Start Up And Growing A Business. Sydney: Francis & Group Stickney C. P., Weil R. L. (2006). Financial Accounting: An Introduction To Concepts, Methods And Uses. Sydney: Francis & Group. Warren C., Reeve J., Duchac J. (2011). Financial & Managerial Accounting. New York: Spon Press. Read More