1. Birth of Firms

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Birth of Firms Beginning a firm – the importance of the entrepreneur Firms (or businesses) begin with an idea. And ideas are exploited by entrepreneurs. What is an entrepreneur? There are many definitions; for example: A short definition: “Someone who starts his or her own business.” Or a longer definition: “An individual who organises and manages labour, capital, and natural resources to produce goods and services to earn a profit, but who also runs the risk of failure; a business person who accepts both the risks and the opportunities involved in creating and operating a new business venture.” Whilst this second definition is quite long and complicated, it goes to the heart of how firms are born – and how they subsequently grow. Let’s look at the key parts of the definition: “An individual…

Most famous entrepreneurs (e.g. Anita Roddick, Richard Branson, Stelios Haji-Ioannou) are well known as individuals. And “sole traders” (i.e. individuals who work alone) are the most common kind of business organisation in the UK. The reality, though, is that very few successful, large firms are solely run by one person. However, it is often the driven energy and ambition of a single person that shapes how a firm develops and performs. Famous entrepreneurs become the individual “face”of their business. …organises labour, A key point. The entrepreneur does not do everything himself or herself. The trick is to capital and natural understand what resources the firm needs when it starts (is “born”), how to obtain them and resources… how to organise them to best effect. Perhaps “technology” could be added to the list of resources that the entrepreneur needs to organise. … to produce goods Entrepreneurs invest their time, energy and cash to make money. They do this by focusing and services to earn a on commercial products. Remember, that a product can be both goods and/or services. To profit… make money, products need customers who are prepared to pay a price that makes the production and sale of the product profitable. ..but who also runs the Every year in the UK there are thousands of firms that are born (even reborn!). Most startrisk of failure, ups lose money at first. Firms that are able to sell their products profitably in the medium to long-term survive the start-up phase and go onto thrive and make money for their investors. Firms that continue to make losses fail (go bust). The investors and other financiers lose what they put in. Starting a firm, like any investment that carries risk of failure, is a gamble. Entrepreneurs are people who are prepared to take the risk. a business person who The essence of an entrepreneur is someone who takes a risk in order to earn a return in the accepts both the risks future. There are numerous examples of successful firms where the entrepreneur seemed to and the opportunities be taking a huge gamble when the firm was born – but lived to see the firm develop into a involved in creating highly profitable and valuable enterprise. and operating a new business venture. Who are the entrepreneurs?

Much academic and other research is undertaken to better understand the profile, attributes and attitudes of entrepreneurs. Much of this research seems to be concerned with seeing if there is a magical formula to being a successful entrepreneur (many people in business are prepared to pay consultants who claim to have the formula!). However, the research is still interesting in giving insights into the kind of people who “conceive” firms. In the UK, the latest available government statistics on business startups (from the DTi’s Small Business Service) reveal that the “average“entrepreneur is o White o Male o Aged 36 o Lives in the south east o Is involved in the construction industry o Is educated to degree level and with previous work experience in the same sector as their own business However, the above profile of the “average” entrepreneur does not necessarily offer a true reflection of entrepreneurial trends in the UK. For example, while men are still twice as likely to start a business the gap is rapidly narrowing and closed by more than 40 per cent in 2002. For a better indication of what type of people are starting up businesses, it is worth looking at the statistics and trends for each characteristic of the entrepreneurial make-up: Age

Gender

Education and career history

Ethnicity

The average age of an entrepreneur might be 36, but there is actually little difference in age between the 18 per cent of the working population aged 16 to 65 that are self-employed. Indeed, 23 per cent of entrepreneurs are aged between 45 and 54. According to research by Barclays Bank, new businesses run by the over-50s are growing in number and looks to continue in line with the UK’s ageing population. Starting a business is being promoted as a viable career option for young people more than ever before, but statistically, while this sector is likely to grow, young people are more likely to consider starting up as a sideline venture or as a something to do later in life. Despite this, one in ten current entrepreneurs is aged 16-24. As mentioned above, men are twice as likely to start a business as women – but female numbers are quickly catching up. In 2002, the gap narrowed by 40 per cent in 2002 and with the government keen to continue more women in business, there’s every indication the trend will continue. But for now, the UK remains near the bottom of global rankings when it comes to the ratio of male versus female start-ups. When compared to 29 developed countries, the UK currently ranks a lowly 26th. Educational background clearly has a large impact on entrepreneurship and rising levels of education can be associated with higher relative rates of enterprise activity. However, a significant minority – 5.5 per cent – has no educational qualifications whatsoever. Interestingly, half of active entrepreneurs have previously worked in the sector they start a business in. Many entrepreneurs “learn their trade” working for someone else, and then set up in competition with their former employers! According to the Small Business Service, every ethnic minority group is less likely to start a business in the UK than the white population. However, there is a higher number of Asian selfemployed people than non-ethnic entrepreneurs as government statistics classify Indian, Pakistani /

Location

Attitude

Bangladeshi and Indian entrepreneurs in separate ethnic groups – together they account for 45% of UK entrepreneurs. What’s more, ethnic groups, especially the black population, are more likely to be thinking about starting a business than the country as a whole. Sadly, the reason many people from ethnic minority groups are only thinking of starting-up could be because of discrimination; 38 per cent of non-white business owners say they have experienced discrimination of which 90 per cent was racially motivated. In 2002 London boasted the largest number of new businesses, followed closely by the South East. In fact, these two regions accounted for around 40 per cent of start-up businesses. However, while still dominant, the number of businesses started in London was actually down on 2001's figures while all other regions in England showed increases. So while, the north south divide still exists, it's not widening. Government initiatives to decentralise enterprise funding means there should be greater support for entrepreneurs outside of the South East in coming years. Unsurprisingly, the differing attitudes of entrepreneurs of entrepreneurs aren't recorded - but perhaps they should be. Regardless of your age, background, sex or ethnicity your success as an entrepreneur is likely to be down to your attitude to business. If you're determined, prepared to make personal sacrifices, have the ability to plan ahead and take on board advice while remaining focusing on your goal and also, of course, have a decent business idea you'll have every chance of success wherever you're from and whatever age you are.

Case Study: Tips on Being an Entrepreneur from an Interview with Stelios Haji-Ioannou The key lessons that Stelio has learned about starting businesses are: o You cannot delegate entrepreneurship - if you are going to make mistakes make them yourself. o Pay attention to the detail of a business, those mistakes in the business model may be small now but they are compounded by growth. o

Don't over estimate what consumers will pay for something that saves then time

o Don't bet the farm on your business, put enough in to have enough skin in the game, an amount that is meaningful but leaves an amount small enough for you to survive.

Case Study: Why Not Everyone Becomes an Entrepreneur Six in ten of all UK employees have thought about starting their own business, but fears about the pressures of being an entrepreneur prevent most from going it alone, according to research. The study, by Lloyds TSB Business, found that 75 per cent of those keen to start their own firm said that they hadn’t realised their ambition because: - They liked the security of working for a larger company, or - Didn’t want the responsibility or - Felt they wouldn’t like the uncertainty

A fifth of those quizzed said they would like to go it alone because they were fed up of working for other people, while 18 per cent said they wanted to turn a hobby or interest into a successful business. However, the biggest barrier for a third of men was that they liked the security of working for a large company, while 28 per cent of women weren’t keen on the responsibility of running their own business. Other perceived obstacles to starting up were not knowing where to find the funds (14 per cent), while 12 per cent said that they wouldn’t know where to turn for advice. Older respondents seemed to be more confident of entrepreneurial success, with less than a fifth of over 55’s worrying about the lack of knowledge and advice, compared to over a third of 16 to 24 year-olds. In another recent survey, researchers found that nearly half of all university undergraduates would consider starting their own business, with many studying relevant subjects to help them become entrepreneurs. Reasons for setting up a new firm There are many reasons why new firms are born, but nearly all are based on a simple concept: an entrepreneur has a good business idea o A good business idea could be an invention, a new product or service, or an original idea or solution to an everyday problem. It might also be: o A gap in the market that the entrepreneur believes he/she can fill o A business related to the work the entrepreneur does already turning an interest or hobby into a business Whatever the idea is, the entrepreneur needs to be sure that it: o Fits with his/her needs as an individual o Is a viable business proposition Before a firm is born, an experienced entrepreneur would consider questions such as: o What is it that the entrepreneur personally brings to the business in terms of relevant experience and expertise? o Is there an existing market - a need for the idea, and customers who will pay for it? (remember – new firms rarely create new markets) o How big is the market and how fast is it growing? o How will the new firm enter the target market? o What are the barriers to entering the market?

o Who are the main competitors? What is their share of the market and how will they respond to the new firm entering the market? o What is special about the good business idea, making it different from similar products or services already out there? (often referred to as “unique selling points” or “USP’s) o What investment is required by the new firm and how will this be financed? o What are the key risks in the investment - what might go wrong?

Start-ups – structures for forming a new business The legal structure a start-up chooses is fundamental to the way it operates. This legal framework determines key issues such as: o Who makes decisions about what the business does o Who shares in the profits and losses o How tax is paid, where legal liabilities rests o The nature of a business' relationships with business associates, investors, creditors and employees There are three options for the legal structure of a new firm: (1) Sole Trader An individual who runs an unincorporated business on his or her own. Sometimes otherwise known as a "sole proprietor" or (in the case of professional services) a"sole practitioner". The sole trader structure is the most straight-forward option. The individual is taxed under the Inland Revenue's Self-Assessment system, with income tax calculated after deduction for legitimate business expenses and personal allowances. A sole trader is personally liable for the debts of the business, but also owns all the profits. Most businesses in the UK are sole traders – but they account for a relatively small proportion of sales and profits earned by firms in the UK. (2) Partnership A partnership is an association of two or more people formed for the purpose of carrying on a business. Partnerships are governed by the Partnership Act (1890). Unlike an incorporated company (see below), a partnership does not have a "legal personality" of its own. Therefore the Partners are liable for any debts of the business. Partner liability can take several forms. General Partners (the usual situation) are fully liable for business debts. Limited Partners are limited to the amount of investment they have made in the

Partnership. Nominal Partners also sometimes exist. These are people who allow their names top be used for the benefit of the partnership, usually for remuneration, but they do not get a share of the partnership profits. The operation of a partnership is usually governed by a "Partnership Agreement". The specific terms of this agreement are determined by the partners themselves, covering issues such as: o o o o o o

Profit-sharing - normally, partners share equally in the profits; Entitlement to receive salaries and other benefits in kind (e.g. cars, health insurance) Interest on capital (the amount invested in the partnership) Arrangements for the introduction of new partners Arrangements for retiring partners What happens when the partnership is dissolved

(3) Incorporated Company Incorporating business activities into a company confers life on the business as a "separate legal person". Profits and losses are the company's and it has its own debts and obligations. The company continues despite the resignation, death or bankruptcy of management or shareholders. A company also offers the best vehicle for expansion and the provision of outside investors. The two most common types of company are: (a) Private company limited by shares - members' liability is limited to the amount unpaid on shares they hold (b) Public limited company (PLC) - the company's shares may be offered for sale to the general public and members' liability is limited to the amount unpaid on shares held by them. Very few new firms start life as a PLC. However, it is common for a new firm to be set up as a private limited company. Specific arrangements are required for public limited companies. The company must have a name ending with the initials "plc" and have an authorised share capital of at least £50,000.The company may offer shares and securities to the public. In return for this right to issue shares publicly, a public limited company is subject to much stricter regulation, particularly in relation to the publication of financial information. The vast majority of companies incorporated in the UK and in other major industrialised countries are private limited companies. The Office of the Registrar of Companies" (based in Cardiff) maintains a record of all UK private and public companies, their shareholders, directors and financial information. All this information has to be provided by Companies by law and is available to any member of the public for a small charge. You can search the Companies House databases at http://ws2.companieshouse.gov.uk/index.shtml Advantages of new firms starting as limited companies

Whilst many businesses prefer to trade as a sole trader or a partnership, nearly all significant businesses operate as an incorporated company. The main advantages of incorporation via a limited company are summarised below: Separate Legal Identity Members' liability is limited ("limited liability")

Protection of Company Name Continuity

New Shareholders and Investors can be easily introduced

Better Pension Schemes Taxation

A limited company has a legal existence separate from management and its members (the shareholders) The protection given by limited liability is perhaps the most important advantage of incorporation. The members' only liability is for the amount unpaid on their shares. Since most private companies issue shares as "fully paid", if things go wrong, a members' only loss is the value of the shares and any loans made to the company. Personal assets are not put at risk. The protection of limited liability does not, however, apply to fraud. Company directors have a legal duty not to incur liabilities in their companies which they have reason to believe the company may not be able to pay. If creditors lose money through director fraud, the directors' personal liability is without limit. The choice of company names is restricted and, providing a chosen name complies with the rules, no-one else can use it. The only protection for sole traders and partnerships is trademark legislation. Once formed, a company has everlasting life. Directors, management and employees act as agent of the company. If they leave, retire, die - the company remains in existence. A company can only be terminated by winding up, liquidation or other order of the courts or Registrar of Companies. The issue, transfer or sale of shares is a relatively straightforward process although existing shareholders are protected via their "pre-emption" rights and by company legislation that seeks to protect the interests of minority investors. The process of lending to a company is also easier than with other business forms. The lending bank may be able to secure its loan against certain assets of the business (a "floating charge") or against the business as a whole ("fixed charge". Approved company pension schemes usually provide better benefits than those paid under contracts to self-employed sole trading businesses. Sole traders and partnerships pay income tax. Companies pay Corporation tax on their taxable profits. There is a wider range of allowances and taxdeductible costs that can be offset against a company's profits. In addition, the current level of Corporation Tax is lower than income tax rates.

Why start-ups are important to the economy New firms are good news for an economy. A dynamic start-up market is a key driver of economic growth. Economic theory indicates that enterprise is a key driver of productivity growth. The creation and growth of new businesses contribute to the beneficial process of what is known as ‘productive churn’ within an economy. This means that efficient new entrants to the market replace less efficient existing businesses. High levels of entry by new businesses can raise the level of competition within markets, both by new entrants attempting to raise their market share and by challenging existing businesses with new innovative ideas and products. Increased

competition stimulates businesses of all sizes to seek efficiency and quality improvements, and to invest and innovate. New businesses also create new employment opportunities. Starting a business can be a positive way out of unemployment, particularly in disadvantaged communities. For example, evidence shows that over the period 1995-99 new businesses were found to be the greatest single source of new jobs in the UK, accounting for 2.3 million extra jobs, of which 85 per cent were in small businesses. . Another study of job creation and destruction in manufacturing between 1980 and 1991, found that small businesses were responsible for between 50 and 68 per cent of job creation. While many small firms may have limited growth ambitions, evidence does suggest that small businesses are also involved in innovation. Evidence suggests small businesses play a key role in diffusing new ideas and technologies. The economic benefits of this activity are amplified when the larger businesses replicate or incorporate them into other products, processes and services, or use them to enhance their own innovation performance How poor information discourages the birth of new firms Not all economies are successful in encouraging the birth of new firms. Market failures in the form of imperfect information may prevent or deter potential entrepreneurs from accessing information that helps them spot, evaluate and exploit good business ideas. The problems of imperfect information arise even before a potential entrepreneur has started up in business. Many people are unsure about: What they need to know to develop a business idea and start a business How to find out what they need to know, and How to access the sources of information and advice appropriate to their needs There are risks associated with starting a business, and obstacles to be overcome, and while some of these are real, some can often be perceived. Without access to full information prior to start-up a potential entrepreneur cannot make an informed assessment about whether a business idea is viable and subsequently how best to start-up the business. Those who do go on to start a business are also deterred from seeking advice because of a lack of information as to what type of support is on offer to them. In addition the quality of information and advice can vary widely and new entrepreneurs often do not have the experience to assess the quality of services. Searching for and assessing the quality of information confers a cost on small businesses, both in terms of time and other resources, a cost that many small businesses may not be able to afford. In addition, entrepreneurs often do not always fully understand the full benefits of business advice, or recognise their own need for support.