10.0.

ENTREPRENEURIAL LEGAL AND FINANCIAL AWARENESS

After the study of this topic, the learners should be able to:

i. Describe the various legal forms of business that operate in Kenya.

ii. Discuss the merits and demerit of the various legal forms of businesses
iii. Explain the problems that entrepreneurs face in starting small businesses,
and highlight the interventions to such problems.
iv. Explain the various sources of business finance.
v. Explain the benefits accruing from contract and sub contracts.
vi. Discuss the importance of networking in developing a small business
Legal aspects of business

There are several forms of business organizations which include the sole
proprietorship, the partnership; joint stock companies the cooperatives and the joint
ventures.

Sole Proprietorship

This is the simplest form of business organization. A sole trader or a sole proprietor
owns the business alone. He pools and organises the resources in a systematic way
and controls the activities with the sole objective of earning profit. He provides all
the necessary capital and other resources alone.

He engages in business on his own account and the business has no existence apart
from the owner. It is therefore not incorporated into a legal entity but a trade
license is needed.

A sole trader is entitled to all the profit and is also responsible for all the losses i. e.
liabilities of the business are personal liabilities of the sole proprietor. He can
manage his business alone or employ people to assist him but he still remains the
final authority.

Sole proprietorships are usually very localized and are most suitable for small
enterprises especially when they are getting started. This form of business is
simpler to start and to manage.

Advantages

Easy to start and to wind up coz there are a few legal intricacies. Compared to
other forms of business organizations, sole proprietorships are easier and simpler
to start and to wind up.

The sole trader takes all decisions alone therefore decisions are made timely and
quickly and implementation is fast because very few people are involved.

He enjoys all the profit from his business and this may encourage him to work
harder. He is also very careful to avoid any loses because he suffers the losses
alone.

A sole trader is in a better position to establish direct contact with customers and
employees. This leads to better understanding of employee and customer needs
hence provision of better services which lead to greater success.

The proprietor is in a better position to keep his business secrets than any other
form of business ownership.

Disadvantages

The sole trader is personality liable for all the debts of the business. If the assets of
the business are not enough to pay liabilities, personal property can be attached by
the creditors.
He is often unable to raise sufficient capital funds since he has to rely on his own
ability to raise money to finance the business. The business will therefore be
restricted by lack of capital.

A sole trader may be unable to attract and/or keep highly qualified persons who
seek opportunities to manage, operate and share in the profit of the business. He
may also be unable to retain good employees because of inability to provide them
with attractive terms and conditions of service.

He suffers from lack of continuity because the life of business is usually limited to
life span of the owner. This means that the business can close down if the owner
become bankrupt, dies, is unable to run the business or is imprisoned. However
some businesses may continue if the next of kin is also business minded.

The proprietor suffers from lack of training and/or specialization. He also has to
work for long hours and all these may adversely affect performance and net
income.

Partnerships

A partnership is a relationship that exits between two or more persons jointly

carrying out a business with the objective of making a profit. Each of the persons is
called a partner and the business is referred to as a firm.

A number of people work together and there is no separate identity of the

partnership from individual partners.

Each partner contributes money, property and labour and in turn they share in the
profits and losses of the business.
Partnership can be formed by agreement between the partners when they want to
use their personal names to constitute the name of the firm. If the partners want to
use a name different from their own, the firm’s name must be registered with the
Registrar General’s office.

Partnership is either permanent or temporary. A permanent partnership is intended

to continue indefinitely since the date of termination is not known at the time of
formation. A temporary partnership is formed for either a specific purpose or
period upon whose expiry is automatically dissolved.

Types of partnerships

They are of two types: General and Limited.

General partnership

All partners are required to have at least one general partner who will carry the
burden of the financial liabilities of the entire organization.

Limited partnership

This requires that there must be at least one general partner and one or more
limited

partners. Limited partners provide capital without assuming financial liability

beyond the amount they have invested in the organization.
NOTE: Normally, a partnership can have a minimum of two and a maximum of
twenty members. In some instances, especially in firms which offer personal and
professional services, the membership can go to a maximum of fifty provided each
member is a professionally qualified person as in the case of a firm of practicing
lawyers, engineers, accountants, etc.

The partnership terms are governed by the Kenya’s Partnership Act, 1963 or a

Deed of agreement. Where the Deed exists, it operates instead of the terms of the
Act. The Deed of agreement defines the following terms and conditions under
which the partnership will operate:

Name and purpose of business.

Location of business and commencing date.

Name, address and occupation of each partner.

Status or type or each partner e.g. limited, general, active, dormant, minor or quasi.

Capital to be contribute and what ratios.

Interest rate to be paid to capital (if any).

Remuneration of partners.

How profits and losses will be shared.

Drawings allowable each year.

Duties and rights of each partner

Admission, withdrawal and expulsion of partners.

In the absence of a Deed of partnership, or in the event of an ambiguity in it, the
provisions of Partnership Act will apply. The Major provisions of the Act are the
following:

Capital must be contributed equally and profit shared equally.

No interest should be credited on capital.

No interest should be charged on drawings.

Each partner should taken an active part in management of partnership and no

salaries should be payable.

All decisions should be made on the basis of majority opinions.

Major changes like change of purpose and introduction of new partners should be
on the agreement of all partners.

Books of account must be kept at the principal place of business.

Loan advances by partners will be made at an interest rate stipulated in the

partnership Act.

How partners should be reimbursed if they incur liabilities on behalf of

partnership.

All partners have the right to inspect all books of accounts.

The partners cannot carry out any competing business.

On dissolution of a partnership settlement should be as follows:-

Loan repayment

Capital repayment
Surplus repaid on equal profit sharing basis.

Types of Partners

General partner: Has unlimited liability for the firm’s debts.

Limited liability partner: Has limited liability in the partnership.

Active partner: This is a partner sharing in capital contribution, management and

shares in the profit liabilities of the business. He may be given a fixed area of
responsibility e. g. sales. He is disclosed to the public as being a partner.

Secret partner: A limited partner who actively participates in the management of

the firm and is not disclosed to the public as being a partner.

Silent partner: Refers to a limited partner who does not participate actively in the
management of the firm and is disclosed to the public as being a partner.

Nominal partner: Is not one of the owners or actual partners of the firm but allows
his name to be identified with the business. He does contribute any capital or take
any part in the management of the firm. He however becomes liable for the firm’s
obligations in unlimited basis. The nominal partner lends his name be used for by
the business for a fee. The business benefits because it uses the partner’s name for
promotional purposes. Such a partner must therefore be a well-known person who
can enhance firm’s prestige and reputation.

Quasi partner: Is one who is presented to the public as a partner although he

contributes no capital and does not participate in the management of the firm. He
may share the profits and liabilities of the firm.
Minor partner: This is a person serving as a partner while he is under the statutory
majority age of eighteen years. As a minor, his liability is limited to his capital and
on attaining the statutory majority age, he will rank as an active partner with
unlimited liabilities.

Advantages of Partnerships

Ease of formation: Formation is easy because all that is needed in a partnership is

an agreement between partners (written or oral) therefore making it free from
complicated legal requirements.

Additional sources of capital: Partners can sometimes raise more capital than a sole
trader since ownership vests in a group of two or more (maximum twenty). It is
also more creditworthy than a sole trader.

Broader management base: Each partner may have expertise in different functions
of the firm such as finance and sales. This leads to increased performance and
profitability. Decision making and consultations are shares for mutual benefits.

Ease of expansion: Expansion can be done very easily by increasing the size of
partnership including addition of specialists’ skills.

Sharing losses and liabilities: Liabilities are better spread to a number of persons
thus reducing the burden on any one person. This encourages more people to join
partnerships because the risks are less than in sole proprietorship.

Duration: Partnerships have longer durations than sole proprietorship because

death or retirement of one partner cannot interrupt the partnership where the
partnership has more than two partners and also where provisions have been made
to perpetuate the partnership.

Disadvantages of partnership

Unlimited liability: This means that if assets of the partnership are not sufficient to
pay debts, the partners are obliged to pay from their personal resources.

Difficulty in making decisions: Authority is divided and decisions may be difficult

to reach due to consultations and this will lead to lose of opportunities.

Lack of continuity: It has a limited and uncertain life. It can be terminated when
partners disagree or one dies or it is incapacitated.

Sharing of profits: This minimizes in direct benefits accruing from personal efforts
especially where some partners may be contributing more than others.

Frozen investment: It is difficult for a partner to withdraw his investments and this
leads to dissatisfaction and lack of commitment.

Limited access to capital: They have difficulties in obtaining large sums of capital
especially long term financing leading to poor development of projects.

Dissolution of Partnership

A partnership may be dissolved in the event of the following circumstances:

 If a temporary partnership (joint venture) at the time of specified period or

on completion of the purposes of the enterprise.
  If a partner notifies the other partner in writing of his intension to dissolve
the partnership.
 If a partner suffers mental ailments, is declared bankrupt or dies.
 If the business becomes unlawful (a law is introduced banning the activities)
 A court can dissolve a partnership on application from a partner or any
interested party.
 If a partner acts contrary to the deed and damages interests of the firm,
where a partnership cannot run at a profit, where the prevailing
circumstances make it only fair and just to dissolve the partnership.

5.1.3 Joint Stock Companies

A joint stock company refers to a corporate association of a number of people for

some common object or objects. The members of a joint stock company contribute
capital to form a common stock to carry on a business usually for profit.

A joint stock company is a corporate body i. e. it is created under the law and has
an entity of its own quite separate form members who own it.

Therefore, under the law, a joint stock company is a fictitious but a legal person
that can enter into contracts, own property, incur liabilities, sue others and and be
sued by others.

It can only do what it has been formed to do.

10.3. Types of Companies

They can be grouped into two categories: registered and statutory companies.
Statutory Companies

They are created by an Act of parliament. The powers and functions of these
companies are defined by the Acts that create them. Most Companies owned by the
Kenya Government (commonly referred to as parastatal organizations) fall in this
category e. g. Agricultural Finance Corporation (AFC).

Registered Companies

These are companies that are formed, registered and operate under the Companies
Act, 1962, Cap. 486, Laws of Kenya. These constitute the most common type of
companies and are the main focus for this course topic.

Registered companies may further be divided into public, private, limited or

unlimited companies.

Public Companies

These companies must have a minimum membership of seven but there is no

maximum number. Their shares are freely transferable usually through the Nairobi
Stock Exchange. Shares and debentures are open for public subscription.
Certificates of trading and annual audit accounts are compulsory. The minimum
number of directors is two. They may have limited or unlimited liability.

Private Companies

They can be described as an advanced form of partnership. The minimum

membership is two and the maximum is fifty excluding past and present
employees. Their shares are not freely transferable. They cannot offer shares or
debentures to the public for subscription. They must have at least one director.
They commence business on receipt of Certificate of incorporation from the
Registrar of Companies. Presentation of prospectus and audited accounts is not
compulsory for private companies.

Limited and unlimited Companies

In a limited company, the liability of members is limited to a stated amount,

usually to the face value of shares a member holds in the company.

The liability of unlimited companies is unlimited like those of sole traders and
general partners. There are however no unlimited companies in Kenya.

Formation of a Company

Persons intending to form a joint stock company are required to furnish the
Registrar of Companies with the following documents:

Memorandum of Association

Article of Association (or adoption of model Articles, termed Table A in the Act).

List of Directors, with details of names, addresses, occupations, shares subscribed

and statement of agreement to serve as directors.

A statement signed by directors stating that they agree to act as such

A declaration that the necessary requirements of registration have been duly

complied with. This declaration can be signed by the company Secretary or by one
of the directors or promoters of the company.

If the documents are found to be in order by the Registrar of Companies, he may

ask the promoters of the company to pay the necessary registration fees upon
which a Certificate of Incorporation giving legal entity to the company is issued.
 The Memorandum of Association (MoA)

It is the most important document to be prepared when forming a company. It lays

down and defines the powers and limitations of the company. It contains the
following six clauses:

Name Clause: This states the name of the company ending in “Limited”. The name
of the company should not be confused with a name of another existing company.
The name should also not give a false idea of the nature of business. Names with
political connotations are normally not acceptable.

Situation Clause: The clause states the domicile of the company i. e. where the
registered office is situated. It is enough to mention the name of the country only.

Objects Clause: It is the most important clause that sets out specifically all the
aims, objectives and purposes of the proposed company. Once incorporated, the
company can operate only within the objects stated in the MoA.

Capital Clause: The clause sets out share capital the company wishes to have. The
total value of all the shares is called the nominal share capital. After completion of
registration, the company can raise this amount by selling shares. The share capital
raised from the sale is referred to as authorized or registered share capital.

Liability Clause: The clause states that the liability of the shareholders shall be
limited.

Declaration clause: This clause states the willingness of the promoters to form
themselves into a limited company. It must be signed by at least seven persons
(promoters) in the case of public limited companies and two persons in the case of
private limited companies.
Articles of Association

It lays down the rules and regulations for the internal organization of the company
as follows:

The different types of shares and the rights and powers of each separate class or
type.

Transfer of shares procedure

Classes of loan capital issued and their rights and powers as well as transfer
procedures.

Kinds of meetings and the methods of calling and conducting meetings.

Details concerning directors as to numbers, election or appointment, qualifications

and disqualifications, powers, duties and liabilities in the management of the
company

Appointment of the secretary to the company under the Act, remuneration, powers,
duties and responsibilities.

Details of the procedures for keeping records of share and loan registers, meetings
of all types, accounting and audit.

Arrangements for the declaration and distribution of dividends on share capital and
interest on loan capital.

Rules governing the appointment of auditors.

Articles of Association can be altered by a meeting of shareholders through a
majority vote and alterations must be forwarded to the Registrar of Companies.

NOTE: A company can choose not to prepare its own Articles of Association and
instead adopt the standard Article of Association in “Table A” of the Companies
Act, 1962, Cap. 486.

Shares

This refers to units of capital of a joint stock company. The unit of capital has a
face value which is also referred to a nominal value. Shares are of two types
namely ordinary shares and preference shares.

Ordinary shares do not carry a fixed rate of return on dividend, while preference
shares do. Preference shares have a first priority on dividends, but the dividends
payable to them is limited to a certain percentage. After the preference shares have
been paid dividends, the ordinary shares are allocated the balance of dividends. In
most cases, only ordinary shareholders have a right to vote on important issues
concerning the company such as the election of directors.

Types of Preference Shares

10.4. Cumulative Preference Shares

These shares are entitled to dividends whether the company makes a profit or not.
If the company makes a loss, the dividends for the year are carried forward to the
following year. When the company eventually makes a profit, the accumulated
dividends will be paid to the preference shareholders.

Non-cumulative Preference shares

These shares are entitled to dividends only during the year when profit is made and
dividends are declared.

Redeemable preference Shares

These shares can be bought back (redeemed) by the company after a specified
period has expired. During that period, profit is paid cumulatively or non-
cumulatively in accordance with the terms of issue.

Irredeemable Preference Shares

These shares cannot be bought back by the company. They can only be sold to
other people directly or through the stock exchange. The dividends are also paid
either cumulatively or non-cumulatively in accordance with the terms of issue.

Debentures

A company can borrow money from the members of the public by selling
debentures.

A debenture is a document or a loan investment that shows that a company has

borrowed specified sum of money from the person named on the document.

The company undertakes to pay a fixed rate of interest for the loan. The rate of
interest on debentures is often lower than on preference shares. Debenture holders
will be paid interest whether the company makes a profit or not.

If the company is to be liquidated, debenture holders will have a claim on the

assets of the company after the creditors, but before preference shareholders and
ordinary shareholders. Debenture holders do not take part in the day-today running
of the company.

Types of Debentures

Mortgage debentures: These are secured i. e. some company property is pledged

against them. In the event of the company’s liquidation, the proceeds of the sale of
the pledged property are used to pay of the holders of mortgage debentures.

Naked debentures: These are unsecured debentures. They can be said to be backed
by all the assets of the company and they also have a floating charge on all the
assets of the company. If the company is being liquidated, the holders of naked
debentures rank among the ordinary creditors of the company.

Redeemable debentures: They can be bought back (redeemed) by the company

within a specified period.

Irredeemable debentures: They cannot be bought by the company. The money

borrowed against them remains outstanding till the company is liquidated.

Advantages of Companies

Limited liability: Even if the company is unable to pay its debts, the shareholders
cannot loose more than the value of their investment in the company according to
the law.

Transferability of ownership: Shareholders in public limited companies can sell

their shares to other people whenever they wish. This renders the ownership in a
company to be easily transferable.
Continuous existence: The legal existence of any company is not affected by the
death of any shareholder unlike the sole proprietor and partnership. If a shareholder
dies, his shares revert to his lawful heirs.

Greater ease of raising capital: Companies can raise capital with greater ease than
sole proprietorships and partnerships. This is because they invite the public to buy
shares. The shares are valued at small amount therefore most members of the
public can afford to buy them. Companies can also borrow large sums of money at
low interest rates because of their legal status and the securities they have.

Specialized management: A company can afford to hire well qualified employees

who can manage the company efficiently because of its size and scope of
operations.

Board of Directors Management: A board of directors may be formed in such a

way that experts in various fields are included. Decisions of these experts are
normally better than a one person’s decisions. The boards of directors discuss
policy issues thoroughly and hence risks of hasty decisions can be avoided.

Economies of scale: Large sums of capital enable large-scale operations which

result in reduced costs per unit produced and consequently higher profit. Large
scale operations also facilitate specialization which leads to efficiency in
operations.

Disadvantages of Companies

Legal restrictions: A company can only operate in accordance with its MoA and
AoA. This may be too limiting if a company wishes to engage in more profitable
activities which are not covered by the above documents and there is no enough
time to alter the document.
Complications in formation: Forming a company is more costly, complicated and
time-consuming. It is more costly because of the legal fees paid to the lawyer who
prepares the MoA and AoA and there is also cost of registration. Formation is
complicated because adherence to certain rules (minimum number of shareholders
and minimum amount of capital) is a necessity.

Impersonality and lack of Secrecy: The dispersed ownership of the company leads
to impersonality and consequent avoidance of personal interest and responsibility.
The shareholders are only interested in dividends and value of shares. The required
publication of financial reports allows others to obtain competitive information
hence the inability to maintain secrecy.

Slow and expensive decision making: In companies, all important decisions are
normally taken by the directors and the more important decisions are normally
taken by the shareholders. This process is slow and often expensive.

Direct control by owners is not possible: Shareholders don’t control the company
directly because direct control is vested in the board of directors. The shareholders
ability to influence the company policy is usually minimal, restricted to their voice
and vote during the shareholders’ AGM.

Taxation: A company is a taxable entity for income tax purposes. It pays taxes
separately from the owners. A corporation tax is levied on the net profit and
earnings distributed to shareholders in the form of dividends are also taxed. This
amounts to double taxation.

Winding up a Company

A company can be terminated voluntarily by the shareholders, the creditors or by

the court.
Shareholders’ voluntary termination: If shareholders decide to wind up the
company, the directors are required to file a declaration of solvency with the court.
The document states that the company’s assets will be sufficient to pay off its
debts. A liquidator is appointed by the shareholders to sell all the assets, pay
creditors and distribute the rest of the money to shareholders.

Creditors’ voluntary winding up: In the event that the assets are insufficient to pay
off the company’s debts, a meeting of creditors is called and they appoint a
liquidator to wind up the company. He sells the assets and pays the creditors.

If the sale of assets realizes less than the amount payable to creditors, a
composition of dividend will be made to discharge the liabilities at the highest
percentage possible. Shareholders in this case forfeit their investments.

If there remains a surplus after paying off all debts in full, then shareholders will
receive a repayment of capital or a dividend rate equating cash available to total
share capital issued.

Termination by court: Where the court is satisfied that the company is unable to
pay its creditors and its continued existence would only result in further
accumulation of debts, it can order liquidation. The court therefore appoints an
Official Receiver who winds up the company. 12.0. LEGAL ASPECTS OF
BUSINESS

12.1 Contractual agreement

A contract is an agreement with specific terms between two or more persons or

entities in which there is a promise to do something in return for a valuable benefit
known as consideration.
Since the law of contracts is at the heart of most business dealings, it is one of the
three or four most significant areas of legal concern and can involve variations on
circumstances and complexities.

The existence of a contract requires finding the following factual elements:

a) An offer

b) An acceptance of that offer which results in a meeting of the minds

c) A promise to perform

d) A valuable consideration (which can be a promise or payment in some form)

e) A time or event when performance must be made (meet commitments)

f) Terms and conditions for performance, including fulfilling promises

g) Performance.

A unilateral contract is one in which there is a promise to pay or give other

consideration in return for actual performance. (I will pay you $500 to fix my car
by Thursday; the performance is fixing the car by that date).

A bilateral contract is one in which a promise is exchanged for a promise. (I

promise to fix your car by Thursday and you promise to pay $500 on Thursday).

Contracts can be either written or oral, but oral contracts are more difficult to prove
and in most jurisdictions the time to sue on the contract is shorter (such as two
years for oral compared to four years for written).
In some cases a contract can consist of several documents, such as a series of
letters, orders, offers and counteroffers.

While small business may to be able to engage in major contracts, they are more
likely to benefit from subcontracting arrangements.

A subcontractor is an individual or a business that agrees to perform part or all of

the obligations of another company's contract with the government.

Officially documenting the relationship between the subcontractor and the prime
via an agreement ensures that each party understands the scope, expectations and
deliverables and protects both parties should an issue arise.

Advantages of Subcontract

Agreements for Subcontractors

Subcontracting opportunities are largely taken by small companies who may not
feel ready or to bid competitively for prime contracts or who may not have all the
necessary skills to do so.

The advantages of a subcontract include:

 Increasing annual profits
 Working on large government procurements
 Increasing working capital
 Gaining experience with a diverse workforce
 Expanding and/or diversifying products (growth opportunities)
 Networking to develop strong business relationships (enhancing
opportunities to become a prime in the future)
  Realizing advancement in management and technical skills
 Increasing contract awards

Tendering procedures

These are procedures that are designed to ensure that the government/companies
achieve best value from all the money they spend.

The value of a contract determines the procedures that all company/government

officers must follow with respect to how many quotes they need to obtain, or
whether a tender process must be entered into.

There are different types of tenders that may be used in procuring different goods
and services. They include:

a) Restricted tender

Suppliers who respond to advertisements expressing an interest in tendering are

required to complete a pre-qualification questionnaire to show that they have
sufficient experience and resources to meet the needs of the procurement
opportunity.

Only suppliers who are subsequently short-listed can be invited to submit a tender.
 b) Open tender

All suppliers who request tender documentation will be invited to submit a tender.
There is no pre-qualification questionnaire or short-listing stage prior to invitation
to tender.

This information is requested as part of the tender itself. The open tender
procedure is normally only used where the known market place is limited.

c) Negotiated tender

A negotiated tender is similar to the restricted tender procedure in that it uses a pre-
qualification stage. A negotiated tender procedure, however, allows the
government/company to negotiate the terms of the contract within strict guidelines
prior to awarding the contract.

For contracts advertised within the country, this process is only used in exceptional
circumstances, for example when a supplier is the sole source of the good or
service required, in cases of extreme urgency, or when the precise specification can
only be determined by negotiation.

d) Competitive Dialogue

A competitive dialogue procedure may be used for “particularly complex

contracts” where an open or restricted tender procedure will not allow the award of
a procurement contract.

Suppliers will respond to advertisements by submitting an expression of interest in

the tender and complete a pre-qualification questionnaire.
Suppliers who are short-listed will be invited to participate in a competitive
dialogue with the Council.

The dialogue is flexible and may include written or verbal submissions and
interviews.

The dialogue may take place in successive stages to reduce the number of
potential suppliers, and at the conclusion of the dialogue the
government/company will ask potential suppliers to submit their final ten
REVIEW QUESTIONS

1.Explain the concept of tendering

2.Discuss the requirements for a valid contract

SOURCES AND TYPES OF BUSINESS FINANCE

New and growing ventures need financing in respect of the type of venture, the rate
of growth and the stage of the ventures development.

.2.1 Types of Business Finance

There are three types of business finance namely Start-up capital,

Working/operating capital and expansion capital.

Start-up Capital: This is capital that is needed to start a business. It is also

referred to as the seed capital. This money is used to meet start up costs such as
rent, permits and licenses, pay roll, initial inventory, utilities, etc.
Working/operating Capital: This is required to meet the daily activities of
business e.g. supplier, advertising, monthly pay, etc.

Expansion Capital: This is needed for business to grow/expand and is used to

purchase capital assets e.g. major machines & equipment.

Sources of Business Finance

There are two broad sources of business finance: Equity finance and Debt finance.

Equity Finance

Equity finance can be sourced from:

Personal savings

Personal funds give a sense of true investment in the venture. Personal funds refer
to the savings that the owner of the venture has been accumulating over a period of
time for the purpose of investing into the business.

Advantages

The owner will have all profit

Reduces debt of the business

The risk of loss provides motivation

Shows good grade to potential lenders.

Disadvantages

In the event of loss, the investor looses all his savings

May cause personal sacrifices

The money may not be enough
Friends and family

This is another popular source of equity financing.

Advantages

An easy source of income compared to other sources

It has less pressure and friction

Involves informal arrangemen

Disadvantages

It risks destroying personal relationships

Encourages unwanted involvement in your business
Partnerships

This refers to selling part of the business to others. It can be done by getting one or
more partners with each partners putting in part of their own money. This is an
easier way of raising the total amount needed. However partners must be able to
get along and make decisions that each accepts.

Advantages

Brings in more cash

If the money is less, the ability to borrow is high

Financial risks are shared

Disadvantages

One must give up part of ownership

One must give up part of profit
11.2 Types of business financing

Debt Finance

When equity sources are not enough, the entrepreneur has the option of borrowing
from other sources.

Lenders consider some factors before lending money i. e. the borrower should be
trustworthy and known to the lender, if the risk is too great they opt not to lend.
Lenders also want to be sure that they will not lose their money on businesses that
may fail. Some of the sources of debt financing include:

Banks

Most people think of banks when borrowing money. Although it is true that banks
lend money to help businesses get started, it is not always easy to borrow from
them. Banks lend money when the risk of losing it is very low. Frequently, they
will only lend to their customers whom they have known for a along time.

Advantages

Quick and easy to obtain

Maintain control and ownership of the business

Repayment can be negotiated

Inflation allows repayment in cheaper currencies

Disadvantages

Interest costs are high (expensive source)

High risks (future profit may be taken to cover payment

Easy to abuse or overuse by diverting

It requires sharing confidential information

Impose restrictions and limitations for the borrower

Cooperative Societies

If one is a member of a co-operative society, then they can be able to borrow

money for business use.

Advantages

Passes large amount of money

Has less requirements to obtain the money

Has lower interest rates

There are no stringent conditions

Disadvantages

There is sharing of confidential information about the entrepreneur

Life Insurance Policies

One can borrow money against an insurance policy. The loans are based on the
cash already paid in and they are offered at lower interest rates. The amount
borrowed is deducted from the coverage available to the beneficiary until the loan
is repaired.

Advantages

They have low interest rates

One can borrow as much as he/she had contributed

Has very little restrictions

Disadvantages

One requires having a policy to qualify for borrowing

If contributions were little, then one can’t get a large sum of money

Venture Capital

This is concerned with high risk deals. It deals with raising of money for high
potential firms which give returns to their investors as quickly as possible

Advantages

More money is available

Money is available for calculated risks

They maintain and control business operation

Disadvantages
Most small businesses don’t qualify
The entrepreneur gives part of control and ownership
11.3.Factors to consider in selecting Business Finance

There are factors to be considered when choosing source of business finance. They
include:
 Cost of money: Money from some institutions is very costly e. g. from
venture capital. An entrepreneur should consider a less costly source
depending on the density of the need for the money.
  Flexibility: Some institutions impose conditions that limit the entrepreneur’s
ability to raise/get more money. One should therefore go for the souerce that
has minimal measures.
 Control: Some sources take over ownership and control e. g. venture,
partnership, etc. If one wants to maintain full ownership and control, then he
should go for other alternative sources.
 Availability: Some sources are not available to some business e.g. venture
capital firms will only sponsor innovative viable businesses. An
entrepreneur should seek for finance from institutions which have readily
available finance for his business.
 Risks involved: Some sources cause potential risks in case of non-payment
e.g. banks can sell your business or close it down.
 Amount of money: The purpose for which the funds are to be used is an
important factor in deciding the amount of money required.
 Importance of the money: The amount of money borrowed and the purpose
in which it is to be used will determine the best source of finance.
 Equity Capital: This is one’s own savings or money fro part of that which
one gets by selling part of interest in his or her business, hence, it is not paid
back.

Government assistance in small business

Governments all over the world have a role of promoting small business by
ensuring accessibility of the following:
 Financing and Credit: The government does this by:
 Providing special funds e. g. Constituency Development Fund, Youth
Enterprise Fund, Women Fund, etc.
  Reducing domestic borrowing hence entrepreneurs don’t have to borrow
from other institutions
 Guaranteeing donor money
 Ensuring accessibility to information: The government also provides
information about the market through district trade offices. The problem is
that much of this information is not passed over.
 Accessing markets and markets opportunities: The government provides
information about the new markets and foreign markets. A government is
set as a big market (the largest consumer of goods and services). E. g.
schools, hospitals, Ministries, e.t.c.
 Accessing technology: Through technology transfer processes. The
government does this through creation of institutions thus promoting
technology e. g. Kenya Industrial Research and Development Institute,
KIRDI is owned by Kenyan government to promote technology.
The government is supposed to provide a conducive environment that is not
heavily legislated (not too many legalities)
The government should layoff at the funning business; remove cumbersome
laws e.g. constant harassment and check down on street sellers.