Formation of a CompanyClass 11 Business Studies Notes

Introduction to Company Formation

Modern businesses often require a large amount of money (capital) and face significant risks due to competition and changing technology. Because of these challenges, the company form of organisation is a popular choice, especially for medium and large-sized businesses.

The entire process, from the initial business idea to the point where a company can legally start its operations, is known as the formation of a company. The individuals who take the initiative, perform these steps, and bear the initial risks are called promoters.

Formation of a Company

Creating a company is a complex process that involves many legal steps. We can break down this process into three main stages:

1. Promotion: The conceptual stage of conceiving the business idea and taking steps to form a company.
2. Incorporation: The legal process of registering the company to give it a separate legal identity.
3. Subscription of Capital: The stage where a public company raises funds from the public.

Promotion of a Company

Promotion is the very first stage in forming a company. It begins when a person or a group of people discovers a business opportunity and takes the initiative to give that idea a practical shape by creating a company.

A promoter is the one who undertakes to form a company for a specific project and takes the necessary steps to get it started. Promoters are the ones who:

• Conceive the business idea.
• Analyse its potential for success.
• Gather the necessary resources, including people, materials, machinery, and finances.
• Complete the legal formalities to bring the company into existence.

Functions of a Promoter

Promoters perform several crucial functions to turn a business idea into a functioning company.

1. Identification of business opportunity: The first step is to identify a potential business idea. This could be producing a new product, offering a new service, or finding a new way to distribute an existing product.

2. Feasibility studies: Not every idea is practical or profitable. Promoters conduct detailed studies, often with the help of experts like engineers and chartered accountants, to check if the idea is viable. These studies include:

   • Technical feasibility: This assesses if the idea is technically possible. For example, is the required raw material or technology available?
   • Financial feasibility: This determines if the required funds for the project can be arranged. If the project requires an enormous amount of money that the promoters cannot raise, it is not financially feasible.
   • Economic feasibility: This evaluates the potential profitability of the project. Even if a project is technically and financially possible, it might be abandoned if it is unlikely to be profitable.

3. Name approval: Once the promoters decide to move forward, they must choose a name for the company and get it approved by the Registrar of Companies. A name will be rejected if it is:

   • Identical or too similar to the name of an existing company.
   • Misleading (e.g., suggesting a business the company is not in).
   • In violation of The Emblem and Names (Prevention of Improper Use) Act, 1950, which prohibits using names of government bodies, the UN, the Indian National Flag, etc.

4. Fixing up Signatories to the Memorandum of Association: Promoters decide who will sign the company's main document, the Memorandum of Association. These signatories are typically the first directors of the company.

5. Appointment of professionals: Promoters appoint professionals like bankers and auditors to help prepare the necessary documents for registration.

6. Preparation of necessary documents: The promoter is responsible for getting key legal documents prepared, such as the Memorandum of Association and Articles of Association.

Position of Promoters

Promoters play a vital role, but their legal position is unique.

• They are neither agents nor trustees of the company because the company does not yet exist.
• They are personally liable for any contracts they enter into on behalf of the company before it is officially formed. These are called preliminary contracts. The company can choose to adopt these contracts after its formation, but it is not legally required to do so.
• Promoters have a fiduciary position, meaning they have a relationship of trust with the company they are forming. They must not make any secret profits at the company's expense. Any profit they make must be fully disclosed.
• Promoters are not legally entitled to claim expenses incurred during promotion, but the company can choose to reimburse them.

Incorporation

This is the second stage, where the company is legally registered and comes into existence. After completing the promotion stage, the promoters file an application for incorporation with the Registrar of Companies in the state where the company's registered office will be located.

Documents Required to be Submitted

The following documents must be submitted to the Registrar:

• Memorandum of Association (MoA): This is the most important document, defining the company's objectives and scope. It must be properly stamped, signed, and witnessed. A public company needs at least seven signatories, while a private company needs at least two.
• Articles of Association (AoA): This document contains the rules for the internal management of the company. It must also be duly signed and witnessed.
• Consent of Proposed Directors: A written consent from each person named as a director, confirming they agree to act in that role and will buy the necessary qualification shares.
• Agreement: Any agreement the company plans to enter into with individuals for roles like Managing Director or Manager.
• Statutory Declaration: A declaration signed by an advocate or a director stating that all legal requirements for registration have been met.
• Receipt of Payment of Fee: Proof that the registration fees have been paid. The fee amount depends on the company's authorised share capital.

Once the Registrar is satisfied that all formalities have been completed, a Certificate of Incorporation is issued. This certificate marks the official birth of the company. The company is also allotted a CIN (Corporate Identity Number).

Effect of the Certificate of Incorporation

The Certificate of Incorporation is the company's birth certificate and has a significant legal effect.

• The company officially becomes a legal entity from the date printed on the certificate.
• It gains perpetual succession, meaning it can continue to exist even if its members change.
• It becomes legally capable of entering into valid contracts.

• If a certificate is issued on January 8th but dated January 6th, the company is considered to have been legally formed on January 6th.
• Even if someone forged signatures on the Memorandum, the incorporation is still considered valid once the certificate is issued.

Capital Subscription

This stage applies to public companies that want to raise funds from the general public. A private company cannot undertake this stage. The following steps are involved:

1. SEBI Approval: The Securities and Exchange Board of India (SEBI) is the regulatory authority for capital markets. A public company must get prior approval from SEBI and disclose all relevant information to protect the interests of investors.

2. Filing of Prospectus: A prospectus is any document that invites the public to subscribe to or purchase a company's securities (like shares or debentures). A copy of this document must be filed with the Registrar of Companies.

3. Appointment of Bankers, Brokers, and Underwriters:

   • Bankers are appointed to receive application money from the public.
   • Brokers help sell the shares to the public.
   • Underwriters guarantee to buy the shares if they are not fully subscribed by the public, in exchange for a commission.

4. Minimum Subscription: To ensure the company has enough funds to start its business, it must receive applications for a minimum number of shares. According to SEBI guidelines, this minimum subscription is set at 90 percent of the issue size. If this amount is not raised, the allotment cannot proceed, and all application money must be returned.

5. Application to Stock Exchange: The company must apply to at least one stock exchange for permission to have its shares traded. If permission is not granted, the allotment of shares becomes void.

6. Allotment of Shares: Once the subscription list is closed and the minimum subscription is met, the company can allot shares to the applicants.

   • Letters of allotment are sent to successful applicants.
   • Excess application money is refunded or adjusted.
   • A document called the 'Return of Allotment', signed by a director or secretary, is filed with the Registrar within 30 days of allotment.

Key Documents in Company Formation

Memorandum of Association (MoA)

The MoA is the company's charter and its most important document. It defines the company's objectives and its relationship with the outside world. No company can legally perform any activity that is not mentioned in its MoA. The MoA contains several clauses:

• The Name Clause: States the approved name of the company.
• Registered Office Clause: Mentions the state where the registered office is located.
• Objects Clause: This is the most critical clause, as it defines the purpose for which the company was formed. The company cannot legally do anything beyond the objects stated here.
• Liability Clause: This limits the liability of the members to the amount unpaid on their shares. [!example] If a shareholder holds 1,000 shares of ₹10 each and has paid ₹6 per share, their liability is limited to the remaining ₹4 per share (a total of ₹4,000).
• Capital Clause: Specifies the maximum amount of share capital the company is authorised to raise. This is known as the authorised share capital.

Articles of Association (AoA)

The AoA contains the rules and regulations for the internal management of the company. These rules are subordinate to the MoA. The AoA covers matters such as:

• Allotment of shares
• Calls on shares
• Transfer of shares
• Procedures for conducting meetings
• Appointment and powers of directors
• Dividends and reserves
• Winding up procedures

Difference between Memorandum of Association and Articles of Association

One Person Company (OPC)

The Companies Act, 2013, introduced the concept of a One Person Company (OPC), which allows a single person to form a company. An OPC gets the benefits of a private limited company, such as a separate legal entity and limited liability, which protects the owner's personal assets.

Characteristics of an OPC

• Only a natural person who is an Indian citizen and resident in India can form an OPC.
• A person cannot incorporate more than one OPC or be a nominee in more than one such company.
• A minor cannot become a member or nominee of an OPC.
• An OPC cannot be a non-profit company (Section 8 company) or carry out non-banking financial investment activities.
• An OPC cannot voluntarily convert into another type of company until two years have passed since its incorporation, unless its paid-up share capital exceeds ₹50 lakh or its average annual turnover exceeds ₹2 crore.