entrepreneurship or informal sector entrepreneurship has been defined in
various different ways by different scholars and authors over time.
a background paper on Informal Sector Entrepreneurship, Colins C. Davis (Davis, 2015) describes the
informal entrepreneur as “those starting a business or are the owner/manager of
a business who engage in monetary transactions not declared to the state for
tax, benefit and/or labour law purposes when they should be declared but which
are legal in all other respects.”
a 2009 brief released by the Organization for Economic Co-operation and
Development defined the informal sector as ‘all legal production activities
that are deliberately concealed from public authorities for the following kinds
of reasons: to avoid payment of income, value added or other taxes; to avoid
payment of social security contributions; to avoid having to meet certain legal
standards such as minimum wages, maximum hours, safety or health standards,
etc.’ (OECD, 2009).
Some misunderstood the inclusion of the word ‘illegal’ in the definition and
interpreted it to mean illicit and criminal activities such as drug
trafficking, human trafficking or even robbery. There is thus need to point out
the fact that ‘illegal’ in this context was meant to show that the activities
go against the law with regard to their mode of their operation but have nothing
intrinsically wrong with their nature as they are.
had the following to say about the same: “Informal entrepreneurship, in sum, is
here defined as involving somebody actively engaged in starting a business or
is the owner/manager of a business that is less than 42 months old who
participates in the paid production and sale of goods and services that are
legitimate in all respects besides the fact that they are unregistered by, or
hidden from the state for tax and/or benefit purposes” (Williams, 2006)
enterprises are said to be operating in the informal sector economy. The
informal sector economy has been described in many di
the various definitions given above, we can deduce the following
characteristics with regard to informal entrepreneurship and the informal
Why have the businesses
opted to remain informal?
procedures required in formalizing the business.
process of starting a formal business, or also converting an informal business
into a formal one through the required legal channels in most countries tends
to be very lengthy and tedious. The process also requires one to provide a
myriad of documents that are not easy to obtain. For instance, in Kenya, for
one to start any business, they must first perform a name search. This is the
process of checking whether the name you’d like to use for your business is
already taken up by another entity or if it is still available for use. If the
name you search is already taken up by another business, you are required to
search once more until you get a name that is free for use. Once you get a name
that is available, you can reserve the name for a maximum of thirty days after
the completion of the name search. From this point, the process can take one of
two paths depending on whether one wishes to start a sole proprietorship, a
partnership or a limited liability company
a sole proprietorship, one would be required to go to the State Law office,
present his/her identification documents and tax number as well as the
documents showing that they have conducted a name search and have paid to have
the name reserved. Once this is done, the applicant is required to fill
multiple documents stating, among other things, the locality of the business
and the primary activities of the business. Once this is done, the applicant
should wait for a period of time and keep checking if the documents required to
make the business formal have been prepared and signed. Ideally, it should take
approximately five working days but past practice shows that at times, this is
not always the case and it may take even longer. Once the documents are
complete, the applicant then needs to visit the Municipal Council offices of
the locality within which they want to open the business. They are to get
licenses and approvals from this offices. The licenses requirements depend on
the type of business one wants. For instance, if one is intending to open up a
business that deals with preparing, selling or distributing food, they must get
a Health and Safety Inspector to guarantee that the food is being prepared and
stored in a place that is clean or if one wants to set up an establishment to
host and entertain people such as a bar or restaurant, they must get a Fire
Prevent and Protection License from the Fire Department of the Municipality. In
brief, there are very many licenses to be acquired simply before being allowed
to start operating.
one who wishes to start a limited liability company, he/she must get the
services of a lawyer once they are done with the name search. The lawyer will
help the applicant come up with multiple documents such as the Memorandum of
Association and Article of Association.
Memorandum of Association is meant to communicate to other individuals that
deal with the company (such as creditors, clients or future investors) what the
company is permitted to deal with as per the law. This document is usually
drafted with great care and diligence by the lawyer. The Memorandum of
Association contains several clauses that help in clearly defining the
business. The clauses include:
clause – It basically states what name the company shall go
-Situation clause – States where the company shall be physically
-Objects clause – This clause states what the company is allowed to
do. Any activity carried out by the company that is not stated in the objects
clause is illegal and thus deemed ultra-vires.
-Directors Clause – This clause simply states the individuals that
shall be holding the directorship positions in the company.
of Nominal Capital – This shows the amount of capital contribution brought
in by each director and the number of shares each holds.
Article of Association prepared by the lawyer states the roles of the
individuals in the company. It can be described simply as the internal
constitution of the company.
these two documents are prepared and signed by the lawyers, they are sent to
the Registrar of Companies for inspection. If the applicant has fulfilled all
the requirements set forth by the law, the company is issued with a certificate
of incorporation. The documents are then forwarded to the government’s social
security office where the directors of the company are given notice that they
shall be remitting statutory social security contributions on behalf of all
their members of staff. The company is then issued with a social security
identification number. After this, the company documents are forwarded to the government’s
hospital insurance fund. Here the company is issued with an identification
number and the directors are notified that they are required to remit the
contributions on behalf of their members of staff every month.
the documents are sent back to the Registrar of Companies from where the
directors of the company can collect them and get the company its own tax
identification number thereafter.
all this, the company must get licenses from the Municipal authorities (similar
to the way a sole proprietorship would have.) The process is even longer and
more tedious if the company is meant to go into a specialists industry such as
provision of banking, insurance, academic or consultancy services because there
are industry regulators that have made by-laws governing the entrance of new
process, in its entirety takes approximately three months. It is unnecessarily
lengthy as it involves the applicants visiting government numerous offices,
joining very long queues and at times, getting attended to by unenthusiastic
employees who drag their feet in service delivery. Once an individual learns of
all the loops and hurdles they have to jump through in a bid to make their
business more formal, they feel very discouraged and would rather opt to stay informal
as it is simpler and it is working.
many statutory requirements and disclosures upon formalization.
applies mostly to limited liability companies. Upon formalization, there are a
multitude of government agencies and industry regulators that require the
company to disclose facts about its activities. For instance, in Kenya, there
exists the National Industrial Training Authority that requires that all
companies submit the number of full time employees, part time employees,
temporary staff and interns working in the company on a monthly basis. They do
this so as to compute the amount of training fees that the employer should pay
to the training authority.
Energy Regulatory Commission requires annual energy audits for all companies so
as to determine if they are energy operating in a manner that is energy
efficient. The energy audits must be conducted by independent third parties
that tend to be very expensive.
Registrar of Companies also requires companies to file annual returns. Most
companies do not understand why they are required to do so as these returns do
not help the government get any new information pertaining the company’s
operations yet the companies are charged for this filing process.
Kenya Revenue Authority also requires companies to file their tax returns.
These returns can be filed on either a monthly or an annual basis depending on
the kind of income being declared. The filing, though not as cumbersome as it
used to be, is a tedious process.
disclosure requirements keep increasing as the time goes by and at a point may
get to a point where there are so many disclosures required that a company’s
core focus may switch from what it was initially meant to be doing to simply
penalties that may come after formalization.
Once a business has been
made formal, it is subject to a lot of scrutiny from multiple government bodies
whose role is primarily oversight and regulation. To ensure that these bodies
have the power to enforce their mandate, the government allows them to charge
penalties whenever a company does not adhere to what the regulatory authority
requires it to do. Whilst this is a very good way of ensuring that the law is
adhered to and all players in an industry do as is expected of them, the heads
of the different regulatory authorities have taken advantage of this and
usually use this as an opportunity to enrich themselves. They make the
penalties very stringent and thereby making it difficult for companies to pay
In Kenya, very minor
violations of the law attract Goliath sized penalties that end up hurting
businesses financially. For instance, the National Industrial Training
Authority in Kenya has made it mandatory for all employers to pay a
contribution for all its members of staff. The monthly fee per member of staff
is approximately 0,40 €. However, failure to pay this amount gives rise to a
penalty of approximately 40€. This is a penalty that is ten times the amount of
the initial sum to be paid. Also, if the employer fails to pay this penalty
attracts an interest charge that is compounded at 5% per month. This makes it
the cost of remaining compliant very expensive and as such, most entrepreneurs
will opt to remain informal as a way of avoiding all this possible penalties.
assured of many benefits upon formalization
When one makes their
business formal, it is usually expected that they will get access to additional
benefits. Such benefits may include easier access to credit facilities, access
to business acceleration programs as well as access to business incubator
This, as time and
industry practice have proven, is not always the case. This has been the case
in many developing countries. As was highlighted by Vusi Thembekwayo, a South African
entrepreneur, the bodies set forth by the government to add value to businesses
once the businesses are formalized are sleeping on the job. He was speaking
about a government body whose primary job was to provide finances at zero
interest to help startups in running their operations. The government body had
allocated a majority of its resources towards funding its recurrent expenses as
opposed to having more resources directed towards helping the startups within
the country that need the business acceleration services that it provides. This
is not an isolated case. In Kenya, there exists a government body called the
Youth Fund whose primary purpose is to provide funding alongside other business
acceleration services such as mentoring and coaching. However, the Youth Fund
is always dragging its feet and never hastens when it comes to assisting the
formalized businesses that are mostly run by the youth.
Formalizing your business
in most developing countries is not necessarily a guarantee that you will receive
any form of value addition. For this reason, entrepreneurs will view the
process of formalizing as unnecessary and thereby avoid it at all costs.
related to formalization.
process of formalizing a business requires the assistance of qualified
professionals such as lawyers and accountants. Usually these professionals are
not cheap to come by. Thus, entrepreneurs trying to formalize their businesses
must spend a substantial amount of money so as to get quality services.
are expenses that some entrepreneurs are unwilling to incur and as such,
informal business remain the preferred mode of operation by most entrepreneurs.
Cases for Informal
expenses in setting up and operating
as an informal business allows one to be able to go about their core business
without having to register with the government. This means that the informal
business owners do need any lawyers to help in drafting their Memorandum and
Articles of Association and file any annual returns to the Registrar of
Companies nor do they need any accountants to constantly do their tax returns
on a month by month or a year by year basis. That aside, they also do not need
to pay any fees to any sort of industry regulator as they are operating under
their radar. This makes it really affordable to start and keep operating an
informal business. This is primarily why most entrepreneurs choose to operate
their businesses as informal enterprises instead of choosing to have them
formalized by registering with the government.
an informal business involve less complexity than operating a formal one. This
is because the informal businesses operate in a manner that makes them
incognito to the authorities. This way, there are no industry regulators
looking over your shoulder every now and then to ensure that you are complying
to all laws and regulations governing the specific industry that you are
operating within. Also, the government in itself is not forcing the
entrepreneurs to pay any form of direct taxes, health insurance for all its
members of staff or any form of social security. This makes administrative work
very simple on the part of the entrepreneur as they simply have to focus on
their core operations and nothing more.
because the enterprise does not need to be compliant to the law, there is no
need to have additional departments or functions like the ‘Audit, Risk and
of these make it very simple for the enterprise to flourish as there is not
much complexity involved in the day to day functions.
led to the employment of many individuals.
informal sector has employed a majority of the population in many developing
instance, in Kenya, the informal sector is solely responsible for the direct
employment of approximately twelve million individuals out of the entire
population of approximately twenty million individuals that are of employable
age. This means that that the informal sector economy provides a means of
sustenance for at least sixty percent of the population in the country. This
means that without the informal sector economy, a vast majority of the
country’s population will be without a means of providing for themselves, their
families, educating their families.
that the informal sector economy be abolished will only result in the
destruction of millions of jobs but also result in the rise of crime as
individuals are busy trying to find a way of surviving.
as much as indirect businesses make a deliberate effort to avoid paying direct
taxes, they still contribute towards revenue generation for the country’s
revenue collection agents. For instance, they pay Value Added Tax for most of
the inputs they use in the production of their goods and services. By so doing,
the merchants that sell them the goods collect the value added taxes and remit
it to the government.
the employees contribute towards the country’s revenue collection by spending
the money they earn from the business.
not generate government any revenue from direct taxes.
business do not remit any form of direct tax to the government. This is because
they are not registered in any of the government’s databases and as such, any
profits they make can go untaxed. Also, their employees can receive their
salaries and wages without the employer remitting any sort of taxes security to
the government on behalf of the employees. This means that the government is
losing on two fronts, the business not remitting taxes and the business not
remitting any taxes from what it pays the employees.
in the informal sector do not have any kind of health insurance or social
security organized by the employer.
the informal sector economy, employers do not remit any contributions for
social security or health insurance on behalf of their employees as they are
mandated to by law. This means that the employees have to get their own health
insurance covers and contribute for their own retirement fund. Often this is
not the case as a vast majority of people in the informal sector economy receive
wages that are lower than the minimum wage allowed in the country. There is
only a very small percentage that earns higher than the minimum wage. This
means that almost all people working in the informal sector economy literally
live from hand to mouth on a daily basis. Most of the money they earn goes into
servicing immediate needs for survival such as buying food, paying rent for accommodation,
buying clothes, paying for education and any other immediate needs as they may
arise. This means that very little is left for saving for future needs or for
contributing to pension and/or health insurance. The end result is that most
individuals go without health insurance cover for themselves and their
immediate dependents. This is particularly dangerous because the individuals
cannot predict when any sort of disease can choose to strike. So when they do
fall seriously ill, they often have to call for help from friends and relatives
to raise funds that will help in getting them the much needed medication they
when these individuals retire from active employment, they do not have any
pension scheme to which they have contributed to and neither do they have any
pool of funds that they have saved on the side. This means that they merely
have to rely on their children, friends and family for support in their old
age. This increases the dependency ratio in the country and places enormous
strain on the little resources that are available.
to regulate and control
that operate in the informal sector do not register with any government agency
or industry regulator. This makes it almost impossible for them to be regulated
as they are operating under the radar of the government. Therefore, the
government cannot control the nature of the transactions that they are
operating under the radar of the government. Therefore, the government cannot
control the nature of the transactions that they get into, the kind of goods
and services they offer as well as the quality of the goods and services that
are being sold.
means that the informal business can cause serious harm to the consumers. For
instance, cases of food poisoning or diarrhea outbreaks brought about by
informal businesses that sell food are not unheard of.
Kenya, the central government in collaboration with the municipal council
authorities have tried their best to get the informal businesses to cease
operations but to no avail. The best they have managed to do is get rid of a
couple of them from different establishments, but the instant they are done,
more informal businesses set up shop and continue operating where others had
How can the encourage the
formalization of businesses
informal sector economy is a means sustenance for many individuals in
developing countries. The government cannot thus just try eliminating it as it
will lead to a viscous cycle that will spiral downwards really fast.
rid of the informal businesses will mean that many individuals who have relied
on this line of work for sustenance are suddenly jobless and the economy is not
growing fast enough to create employment for all of them. Thus, in a bid to
survive, individuals will result in criminal activities such as robbery and
drug peddling to get by. The lack of active employment by many young people
will also result in them indulging in social vices such as excessive drinking,
use of illicit drugs, gambling and indulging in irresponsible sexual behavior.
The end result will be a society that has youth that are unable to work as a
result of numerous addictions, an increase in population in an economy where
the government that cannot provide basic social services and a dwindling
economy because production has been significantly reduced.
bearing this in mind, the government cannot do away with informal businesses
but instead, it has to come up with ways to encourage them to become formal.
Below are some of the measures that can be adopted so as to encourage informal
businesses to become formal.
the number of different taxes and duties that they are subjected to.
formal businesses in Kenya are subject to multiple different taxes, such as income
tax, withholding taxes on different incomes, value added tax and excise duty.
Most of this taxes are direct taxes meaning that the entities must bear the
legal and monetary burden of paying the taxes. This has a strain on a business’
liquidity and cash flows. The government must factor in that small businesses that
have just been set up are not as financially equipped as already equipped as
already established entities and because of this, they should be treated with a
degree of care an leniency to help them to grow into bigger and more stable
such, it in advisable that the government create a provision in tax law that
help the new businesses legally avoid paying some direct taxes. This will be of
help the businesses in staying cash flow positive. Being able to stay in this
state of having cash present means that the businesses will be able to pay
the process of starting the informal business easier. Eg all services to be
under one roof.
incentives. Eg business acceleration programs, incubation centres.
down on informal biznas in worst case scenario