CHAPTER 5: BUSINESS FORMATION

FUNDAMENTALS OF ENTREPRENEURSHIP (ENT300)

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 Chapter objectives
• To understand different aspect of business formation
• To discuss the various ways to establish new venture
• To explain the advantages and disadvantage of each alternative
in starting a new venture

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 Chapter 5 Contents

5.1 Starting from scratch

5.2 Buying an existing business

5.3 Family business succession

5.4 Acquiring a franchise

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 Introduction
There are four (4) common methods of starting a new venture:
1) Starting from scratch
2) Buying an Existing Business
3) Family Business Succession
4) Acquiring a Franchise

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 5.1 Starting From Scratch
• The most popular method among start-up entrepreneurs.
Entrepreneur has to make decisions on:
a. Appropriate form of business
b. Business or trade name
c. Business and product/service image
d. Suitable location of the business
e. Appropriate funding to kick-start the business
f. Proper business planning for everything that needs to
be take into consideration.

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 Advantages of Starting From Scratch
a. Entrepreneurs are free to make his/her own decisions.
b. Entrepreneurs have the opportunities to try and practice his/her own
ideas.
c. Entrepreneurs are free to choose suitable business location and
premise, and acquiring appropriate machine and equipment for the
business.
d. Entrepreneurs are free to develop business image and personality that
suits their desire and interest.

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 Disadvantages of Starting From Scratch
a. Entrepreneurs need to put in a lot of efforts. It requires more time,
energy and money in ensuring the business kick-off.
b. Higher chances of losses due to high project implementation cost.
c. Entrepreneurs are not able to accurately estimate sales, cost and
profit. ( zero business history (i.e. sales record, costing and so on)
d. A new venture usually has no track record. Therefore, it is difficult for
entrepreneurs to convince the financial institutions in getting the
financing

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 5.2 Buying an Existing Business
• Entrepreneurs start a new venture buy taking over an existing business
either buying the whole business or partial shares in the existing
business.
• Entrepreneurs must “investigate” before buying. previous owners have
reasons why they wanted to sell their business. So, it is the
entrepreneurs’ responsibilities to “investigate” the business that they
want to buy as well the “background” of the existing owners

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Advantages of Buying an Existing Business

a. The time entrepreneurs spent to start the business is faster

compared to starting a new venture form scratch
b. The probability of getting the financing is greater if the existing
business has a good track record.
c. Existing market and loyal customers of existing business.
d. Established networking with suppliers, supporting agencies and
communities.

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Disadvantages of Buying an Existing Business
(cont.)
a. Buying existing business requires bigger amount of capital either to
buy the whole business or part of the business.
b. If the existing business is not well managed by the previous owner,
entrepreneurs need to put in a lot of efforts, money and time to
improve the situation.
c. Entrepreneurs have to respect and abide the agreements that have
been made by the previous owner with related parties (i.e. suppliers,
agencies etc.)
d. Conflicts could arise between the new owner and existing employees

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 5.3 Family Business Succession
• Entrepreneur is the successor of the business which was started by
the earlier family members (predecessors).
• Entrepreneur did not face the difficulties of starting-up a new venture.
• E.g of family business in Sarawak are ShinYang Grp of Co., Interhill
Group of Co.
• Other examples such as Habib Jewels, Kuok Group of Companies

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Example of family owned/succession business

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 Levels of Family Business
Generally, there are four levels of family business:

Level 1: Business Inception

(the founder)
Level 2: Business Growth & Development
(the founder & 1st generation)
Level 3: Business Maturity
(the founder,1st generation & 2nd generation)
Level 4: Business Transition Period
(1st generation, 2nd generation & 3rd generation)

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 Challenges of Family Business
a. Financing – debt financing versus equity financing
b. Liquidity/Cash – family’s need for cash versus business’s needs for
cash
c. Transition period – older generation versus new generation (to let go
or not to let go – ownership & management power)
d. Succession - finding the right successor (competent, motivated, and
the most important getting consensus from all family members)
e. Emotion – family interest versus business interest
f. Rivalry – siblings, cousins

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 Advantages of Family Business
a. Freedom and flexibility in decision making.
b. Pride of family culture, high commitment and motivation lead to
business stability.
c. Family members willingness to “sacrifice” their time and money (e.g.
no salary taken for 1st year of operation).
d. High possibility of achieving great monetary success due to high
commitment.
e. Family members have good exposure to business environment.

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 Disadvantages of Family Business
a. Unstructured early-stage business organization.
b. Early-stage limited financial resources.
c. Family conflicts such as siblings and/or cousins rivalry.
d. Nepotism among family members (e.g. incompetent family
member is given a better management position).
e. Traditions practiced by older generation passed on to new
generation could lead to resistance to change.
f. Difficulty in getting the right successor.

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 5.4 Acquiring a Franchise
• Another alternative of starting a new business.
• A franchise is a product and/or service distribution system which is
governed by a contract.
• Made between two parties namely, the franchisor and the franchisee.
• The franchisor is a company which sells the right to another party to
operate the franchise.
• The franchisee is a person who purchases the right from the franchisor
to operate the franchise.
• Operating a franchise includes selling and marketing the products and/or
services using the trade name and trade mark, as well as a set of
systems developed and owned by the franchisor.
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 Acquiring a Franchise (cont.)
• The right to operate the franchise granted by the franchisor to the franchisee
involves a few payments made by the franchisee agreed upon the signing of
a franchise. These fees are:
• Franchise Fee – one-off payment made by the franchisee to purchase the
right to operate the franchise
• Royalty - an on-going payment made by the franchisee to the franchisor
based on the percentage of sales as agreed upon the signing of franchise
contract (monthly or yearly)
• Advertising and Promotional Contribution - an on-going payment or
contribution made by the franchisee to franchisor ’ s advertising and
promotional fund.

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 Types of Franchise Systems
Two major types of franchise system:

① Product/Trade name Franchise

② Business Format Franchise

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 Product/Trade name Franchise
• This type of franchise system involves the franchisee acquires
sales right which includes the trade name, trademark, and/or
products from the franchisor upon the signing of the so-called
dealership contract, and agreed to sell the product line identified
by the franchisor.
• This type of franchise system is commonly used in the
automotive, petrol kiosk and service station, soft beverages, and
tyre industries.

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RBP/UiTMKS/FPP/ENT300
 Business Format Franchise
• This franchise system is also named “ full-fledge franchise ” The
franchisee is granted the right to manufacture and market the
franchisor ’ s product and/or services using a complete franchisor ’ s
business “set-up” which comprises of intellectual properties (trade name.
trade mark, etc.); marketing strategies (pricing structure guideline,
promotional activities etc.), guided operational activities (franchisee is
equipped with operation manual and has to undergo a training), premise
settings and layout ( exterior and interior layout; ambience, color scheme
and decoration must in-line with franchisor’s brand and image).

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 Advantages of Franchising
To the Franchisee:
a. Lower business risks as franchisee shares the business risks with the
franchisor.
b. Better market acceptance of products and/or services offered as they
are established products and/or services of the franchisor.
c. Benefits of economies of scales
d. Guidance by the franchisor’s management team
e. Continuous support from the franchisor and government agencies
that involved in the development franchise industry.

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 Advantages of Franchising
To the Franchisor:
a. The franchisor ’ s business expansion can be done through
recruitment of new franchisees.
b. Benefits of economies of scales
c. Lower business risks as franchisor shares the business risks with the
franchisees.
d. Problems related human resource management is reduced due to the
fact that the franchisees have to manage the human resource related
matters themselves.
e. The franchisor can put more focus on product research and
development since business expansion is done through franchise
system.
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 Disadvantages of Franchising
To the Franchisee:
a. Limited freedom and flexibility to manage the business according to
franchisees’ desire
b. The franchise right granted by the franchisor has its price to pay; the
franchise fee, royalty and advertising & promotional contribution
c. Limited product varieties; the franchisees are allowed to market and sell only
the franchisor’s products
d. Fear of chain-reaction; bad reputation and tarnished image due to the fault of
either the franchisor or the franchisee would affect the whole franchise
system

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 Disadvantages of Franchising
To the Franchisor:
a. Franchisee conformity; it is difficult to manage the franchisees especially
in ensuring the conformity of the operational methods of all franchisees in
the system due to the fact that they are not franchisor’s employees.
b. The franchisor/franchisee goal incompatibility; The franchisor and
franchisees may have different business objectives as well as personal
objectives that could jeopardize the business “marriage”.
c. “Wrong” franchisee; There are franchisees who want an “easy-ride” in
an attempt to gain instant popularity for the business.
d. Competition through imitation of business concept and model

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END OF CHAPTER 5

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