Formation of a company involves a number of steps which are required to be taken from the time a business idea originates till the time a company is legally ready to commence business.
The stages and steps involved in the formation of a company are:- 1. Promotion Stage 2. Incorporation Stage 3. Capital Subscription Stage 4. Commencement of Business Stage.
Company Formation in India (Private and Public Limited Companies): Steps, Stages, India, Important Documents, Contents and Articles of Association
Company Formation – Promotion Stage, Incorporation Stage, Capital Subscription and Commencement of Business Stage
Since a company is an artificial person, it has to be formed according to legal provisions. In India, these legal provisions have been provided in the Companies Act, 2013.
Formation of a company involves various stages which are as follows:
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1. Promotion stage.
2. Incorporation stage.
3. Capital subscription stage.
4. Commencement of business stage.
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All these stages are relevant to forming a public company (also known as public limited company). For forming a private company (also known as private limited company), only the first two stages and a part of the third stage are relevant as it can commence business immediately after incorporation and receiving money from signatories to documents who have agreed to subscribe to the specified number of shares.
Therefore, business commencement stage is not relevant to a private company. Further, such a company cannot invite the general public for subscribing to its shares. Therefore, a part of capital subscription stage is not relevant to it. Let us go through all these stages.
1. Promotion Stage:
The term ‘promotion’ refers to the sum total of activities by which a business enterprise is brought into existence. At the promotion stage of a company, the promoters conceive the idea of promoting a company and the type of activities that it intends to undertake.
A promoter may be an individual (like Jamsetji N. Tata, G.D. Birla, Dhirubhai H. Ambani, etc., the great promoters), a group of individuals or one or more companies (promoting a company by another company or group of companies is becoming very popular). Subsequently, activities related to promoting the company are undertaken.
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These activities are as follows:
i. Identification of business opportunity and the type of business to be undertaken.
ii. Undertaking feasibility study to determine technical, economic and legal viability of the project to be undertaken by the company.
iii. Deciding the name of the company to be formed and getting this name approved from the Registrar of Companies.
iv. Obtaining consent of the persons who will be signatories to documents to be submitted to the Registrar of Companies for getting the company registered. (In the case of a private company, 2 signatories, and in the case of a public company, 7 signatories are required.)
v. Obtaining consent of the persons who will act as first directors (2 required in the case of a private company and 3 in the case of a public company).
vi. Selecting professionals who will prepare various relevant documents required for registration of the company like Memorandum of Association, Articles of Association, etc., and the professionals who will work as first auditors of the company.
vii. Getting relevant documents prepared.
2. Incorporation Stage:
Incorporation or registration stage involves putting an application for registering the company before the concerned Registrar of Companies and getting it registered. In India, there is an office of the Registrar of Companies in each major State of the country. The concerned Registrar is one who is located in the State where the registered office of the company is to be located.
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Incorporation stage involves the following activities:
i. Filing registration application with the Registrar of Companies along with relevant documents (Memorandum of Association, Articles of Association or declaration of accepting Table A which is a model set of Articles of Association, written consent of proposed Directors, certificate of approval of the company’s name, agreement entered with the proposed Managing Director, statutory declaration that all legal requirements for registration have been completed and documentary evidence of payment of registration fees).
ii. Scrutiny of the application and documents by the Registrar of Companies.
iii. Registering the company by the Registrar if all requirements are fulfilled and entering the name of the company in the relevant register.
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iv. Issue of Certificate of Incorporation by the Registrar of Companies.
On issue of the Certificate of Incorporation, the company comes into existence as an artificial person.
3. Capital Subscription Stage:
After a company is registered, it proceeds to get money through allotment of share capital to members. Initially, shares are allotted to persons who are signatories to documents and have agreed to subscribe to the prescribed number of shares. After this, a private company may start its business while a public company is required to get the Certificate of Commencement of Business from the concerned Registrar of Companies.
The procedure for subsequent allotment of shares varies for a private company and a public company. In a private company, subsequent shares are allotted through personal contacts. In a public company, shares may be allotted through public issue of shares.
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The usual procedure for this is as follows:
i. Filing of prospectus with Securities and Exchange Board of India (SEBI).
ii. Getting approval from SEBI.
iii. Appointing managers, underwriters and registrar to the issue.
iv. Appointing bankers for receiving applications for shares along with money and brokers for promoting the issue.
v. Inviting the general public (including institutions) for share subscription.
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vi. On receiving the minimum prescribed subscription, allotting the shares in consultation with the concerned stock exchange where the shares are to be listed for trading.
However, it may be mentioned that it is not necessary for a public company to offer its shares to public; it has only an eligibility for public issue but not a compulsion. When a public company issues its shares to the public, it is called a publicly-held company. When it does not issue its shares to the public, it is called a closely-held company.
4. Commencement of Business Stage:
For commencing the business, a public company has to obtain the Certificate of Commencement of Business from the concerned Registrar of Companies.
For this purpose, the company is required to submit the following documents:
i. A declaration that the shares to be subscribed on cash basis have been allotted.
ii. A declaration that all the Directors have paid in cash for the shares subscribed by them.
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iii. A declaration, signed either by a Director or Secretary of the company, that the above requirements have been complied with.
The Registrar of Companies scrutinises the above documents and issues the Certificate of Commencement of Business if all requirements are as per the provisions of the Companies Act.
Company Formation: Steps, Important Documents, Contents, Articles of Association, Documentary Evidence, Filing and Certificate of Commencement of Business
Formation of a company involves a number of steps which are required to be taken from the time a business idea originates till the time a company is legally ready to commence business.
The formation of a company involves the following stages or steps:
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4. Commencement of Business.
Both a public company and a private company have to undergo promotion and incorporation stages. A private company is prohibited to raise funds from public, therefore, it does not need to issue a prospectus and complete the formality of minimum subscription. A public company however, goes through the capital subscription stage and then gets the ‘Certificate of Commencement of Business.’
Step # 1. Promotion:
Promotion is the first stage in the formation of a company. It includes the steps like identification of a business opportunity, conducting detailed investigation and feasibility studies, analysis of its prospects and taking steps for the formation of a company. The persons who perform all these tasks during the promotion stage are known as ‘promoters’. There is no statutory definition or qualification of a promoter. A promoter can be a person or a group of persons or a company.
Promoter is a person who conceives the idea of starting a business, examines the feasibility of idea, assembles various resources, prepares necessary documents and performs other activities needed to commence the business. These functions are, basically, the steps involved in the promotion of a company.
Steps in the Promotion of a Company (Functions of a Promoter):
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The important steps which promoters take may be listed as below:
1. Identification of Business Opportunity:
The process of formation of a company begins when a promoter identifies a business opportunity or proposition or an idea. The opportunity may be in respect of producing a new product, expansion of the existing unit, making a product available through a different channel, merger of two business units or any other opportunity having investment and profit potential. Then, the feasibility of such opportunity is analysed by the promoter.
2. Feasibility Analysis:
It may not be feasible or profitable to convert all identified business opportunities into real projects. Therefore, before investing the money in the idea, detailed feasibility analysis is conducted in order to investigate all aspects of the intended proposition. Depending upon the nature of product and with the help of professional specialists like engineers, chartered accountants etc.
The following feasibility studies are undertaken:
(a) Technical Feasibility:
Sometimes, the business idea is good but technically it may not be possible to implement it due to non-availability of required technology, raw material or other inputs. The project would remain technically unfeasible until the technology or other proper inputs are made available from alternative sources.
(b) Financial Feasibility:
Every business activity requires funds. If the funds required for the project are large and they cannot be arranged within the available means, then the project is financially unfeasible.
(c) Economic Feasibility:
Profitability is a major concern. A project is dropped just because it may not be very profitable. Generally, businessmen prefer to carry on with proposals which are profitable and feasible.
It must be noted, that the experts hired to conduct the feasibility studies do not automatically become promoters, just because they are assisting the promoters.
3. Approval of the Name of the Firm:
The promoters have to select a name for the company and get it approved from the Registrar of Companies. The Registrar examines the proposed name to find out that it does not resemble with the name of any other existing company. If the name is not identical with any other firm then the Registrar approves the name. Three names in the order of their preference are to be submitted in the application to the Registrar of Companies and the Registrar approves one of them.
4. Preparation of Necessary Documents:
The promoters take steps to prepare legal documents which have to be submitted to the Registrar of Companies for getting the company registered. Some of these documents are Memorandum of Association, Articles of Association, and Consent of Directors etc.
5. Appointment of Professionals:
The promoters appoint professionals such as an advocate, practicing company secretary, mercantile bankers, and auditors etc. to assist in the preparation of necessary documents, which are to be submitted to the Registrar of Companies.
6. Signatures of Subscribers to the Memorandum of Association:
The promoters have to decide about the people who will sign the Memorandum of Association of the proposed company. The people who sign the Memorandum of Association are known as subscribers. They are also the first Directors of the company. The written consent of subscribers to act as directors and to buy qualification shares is also taken.
The Memorandum of Association must be signed by at least 7 persons in case of a public company and 2 persons in case of a private company. Promoters often try to convince influential and experienced businessmen to be the subscribers to the Memorandum of Association of the proposed company.
Important Documents required to be submitted:
The important documents required to be submitted to the registrar of companies are:
(1) Memorandum of Association,
(2) Articles of Association,
(3) Consent of Proposed Directors,
(4) Copies of Agreements,
a. Statutory Declaration under section 7 (i) (b) of Companies Act 2013,
b. Documentary Evidence of Payment of Registration Fee.
(1) Memorandum of Association:
Memorandum of Association is the most important and principal document of a company. It has been described as the ‘Charter of the Company’ as it contains the powers and objectives of the company, defines the scope of its operations and its relations with the investors and outside world. The company has to work within the limits laid down in the Memorandum of Association.
Contents of Memorandum of Association:
The memorandum of association contains the following clauses:
i. The Name Clause:
This clause contains the name of the company with which the company is to be registered.
ii. Registered Office Clause:
This clause contains the name of the state, in which the registered office of the company is proposed to be situated. The exact address of the registered office is not required at this stage, but it must be notified to the Registrar of Companies within 30 days of the incorporation of the company. This clause is also known as the ‘Situation Clause’ or ‘Domicile Clause’ or even The ‘Residence of the Company’.
iii. Objects Clause:
It is the most important clause of the Memorandum of Association. A company cannot conduct any business which is not authorised by its object clause.
The object clause is further divided into two sub-clauses:
The object stated in the object clause must not:
a. Be illegal or
b. Be in conflict with the provisions of the Companies Act
c. Include immoral activities.
iv. Liability Clause:
In case of a company limited by shares, the liability of the members is limited to the amount unpaid on the shares held by the members. For example, Amir, a shareholder is holding 1,000 shares of Rs.10 each on which he has already paid Rs.8 per share. In the event of losses or company’s failure to pay debts, his liability can be only upto Rs.2 per share i.e., Rs.2,000 (1,000 shares @ Rs.2 unpaid). Beyond this, he cannot be called upon to bear losses from his private property.
v. Capital Clause:
This clause specifies the maximum amount of capital with which a company is registered, and the division thereof into shares of a fixed amount and the number of shares which the subscribers to the Memorandum of Association have agreed to subscribe. The company cannot issue share capital in excess of the amount mentioned in this clause.
vi. Association Clause:
In this clause, the signatories to the Memorandum of Association state their intention to be associated with the company and also give their consent to purchase qualification shares. The Memorandum of Association must be signed by at least seven (7) persons in case of a public company and by two (2) persons in case of a private company and one person in case of ‘One person’ company. The undertaking under association clause reads as under- “We, the several persons whose names and addresses are subscribed, are desirous that a company is formed in pursuance of this Memorandum of Association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names.”
The Articles of Association are the rules for the internal management of the company. These are also called the ‘Bylaws of the Company’. It defines the powers, duties and rights of the Board of Directors. These are subsidiary to the Memorandum of Association and hence cannot override the Memorandum.
Therefore, in the event of any conflicting provisions in the two documents, the provisions of the Memorandum of Association will supersede the provisions of the Articles of Association. A public limited company may either have its own Articles of Association or may adopt Table-F, which contains model sets of Articles given in the Companies Act, 2013. There are many sets of Articles of Association given in Table F.
A company can adopt any one. For companies not adopting Table-F, a copy of the Articles of Association, stamped and duly signed by signatories to the Memorandum of Association is required for registration of the company.
The main contents of an articles of association are as follows:
1. Amount of share capital and different classes of shares.
2. Rights of shareholders.
3. Procedure for issue and allotment of shares.
4. Procedure for issuing share certificates.
5. Procedure for transfer of shares.
6. Procedure for forfeiture of shares.
7. Procedure for reissue of shares.
8. Procedure for conducting various meetings.
9. Procedure for appointment of directors.
10. Procedure for removal of directors.
11. Duties, powers and remuneration of directors.
12. Procedure of declaration and payment of dividends.
13. Winding up procedure.
14. Maintenance of accounts and their audit; and
15. Seal of the company.
Alteration in the Articles of Association:
A company can change any provision of the Articles by passing a special resolution subject to following conditions:
(i) Change should not be against the provision of Memorandum of Association.
(ii) It must not result in breach of contract with outsiders.
(iii) It must be in the interest of the company.
(iv) No increase in the liability of the members.
(v) In case of a conversion of a public limited company into private limited company, approval of Central Government or the Company Law Board should be obtained.
(3) Consent of Proposed Directors:
It is a written consent of the proposed directors to act as directors and an undertaking to purchase and pay for shares of the company as given in the association clause in order to ensure that the directors have some stake in the proposed company.
If the company proposes to enter into an agreement with any individual for appointing him as managing director or a whole time director or manager, then such an agreement is also submitted to the Registrar.
A statutory declaration is to be submitted to the Registrar of Companies stating that all the legal requirements under the Companies Act regarding incorporation have been complied with.
This statement has to be signed by any of the following:
(a) An advocate of High Court or Supreme Court, or
(b) Manager or Secretary of the company, or
(c) Person named in the Articles of Association as a Director, or
(d) A Chartered Accountant or Company Secretary or Cost Accountant in whole-time practice.
(6) Documentary Evidence of Payment of Registration Fee:
Along with the above documents, necessary filing fees and registration fees have to be paid before the registration of the company. The amount of fees depends on the authorised share capital of the company. The documentary proof of payment of fee is also to be submitted to the registrar.
Promoters undertake various activities to bring a company into existence. However, a promoter is neither an agent nor a trustee of the company.
1. Promoter is not an agent as the company is not yet registered. He is personally liable for all the contracts entered into by him. These are known as Preliminary Contracts.
Preliminary contracts are the contracts entered into by the promoters with third parties on behalf of the company, before its incorporation:
(i) Such contracts are not legally binding on the company. It cannot ratify these contracts even after its incorporation as company was not in existence at the time of contract.
(ii) Promoters remain personally liable to third parties for these contracts.
(iii) However, the company may enter into fresh contracts with the same terms and conditions in order to honour the contracts entered into by promoters.
2. Promoter is not a trustee of the company, but stands in a fiduciary relationship which is a relationship of utmost good faith with the company which he is promoting and he should not misuse his position. He should not make any secret profits in the dealings, and if he makes, then such profits should be disclosed.
If the promoter does not disclose the secret profits earned by him and the company comes to know later on, then the company can:
(a) Cancel the contract
(b) Recover the purchase price paid to the promoters
(c) Claim damages for the loss suffered. Moreover, they will be liable for punishment for fraud under section 447 of the Companies Act, 2013.
3. Promoters are not legally entitled to recover the expenses incurred in the promotion of the company. However, the company may reimburse such pre-incorporation expenses.
4. The company may remunerate the promoters by making a lump-sum payment or paying commission on the basis of the property purchased or shares sold.
5. The company may allot shares or debentures to the promoters or give them an option to purchase the securities at a future date.
Step # 2. Incorporation:
This is the second stage in the formation of a company. Incorporation means registration of the company under Companies Act, 2013.
After the registrar approves the name, the promoters can proceed with the following steps for the incorporation of the company:
i. Application for Incorporation:
Promoters make an application for the incorporation of the company to the Registrar of Company along with necessary documents in proper form.
ii. Filing of Documents:
The following documents will be filed along with application:
a. Memorandum of Association duly stamped, signed and witnessed. In case of a public company seven (7) members must sign it and in case of a private company, two (2) members are sufficient to sign. It must also contain information about address, occupation and number of shares subscribed by the signatories.
b. Articles of Association duly stamped and signed is to be submitted.
c. A list of directors with their names, address, occupations and age.
d. Written consent of the proposed directors to act as directors and an undertaking to purchase qualification shares.
e. A statement of authorised capital.
f. A copy of the Registrar’s letter approving the name of the company.
g. Notice of the exact address of the registered office. However, it may also be submitted within 30 days of the incorporation.
h. Documentary evidence of payment of registration fees.
i. Statutory declaration affirming that all legal requirements for registration have been complied with.
iii. Payment of Fees:
Along with the above documents, necessary filing fees and registration fees at the prescribed rates are also to be paid.
iv. Verification and Registration:
The Registrar verifies all the documents submitted and the documentary evidence of payment of registration fees. If he is satisfied that all the statutory requirements regarding the registration are complied with, he enters the name of the company in his register.
v. Issue of Certificate of Incorporation:
The registrar issues a ‘Certificate of Incorporation’ which may be called the Birth Certificate of the Company. From this date the company is considered as a separate legal entity. With effect from November 1, 2000, the Registrar allots a CIN (Corporate Identity Number) to each company registered and incorporated.
Relevance of the Certificate of Incorporation:
A company is legally born on the date printed on the Certificate of Incorporation. The Certificate of Incorporation is the conclusive evidence of the legal existence of the company.
The impact of the certificate of incorporation is as follows:
(a) Company gets the status of separate legal entity with perpetual succession.
(b) Company is entitled to enter into valid contracts. It cannot exercise borrowing powers until the Certificate of Commencement of business is granted.
(c) Certificate of incorporation of a company is a conclusive evidence irrespective of any deficiency in its registration. For example, issue of certificate will make the incorporation valid even if a person has forged a signature on the Memorandum of Association or the company has been registered with illegal objects. Therefore, the Registrar should be very careful before issuing a certificate of incorporation.
A private company cannot immediately commence its business after obtaining a Certificate of Incorporation. It also has to obtain certificate of Commencement of Business.
Step # 3. Capital Subscription:
i. Prospectus:
A public company can raise funds from the public by issuing shares and debentures. For this, it has to issue a prospectus.
A public company must issue a prospectus inviting applications for shares from the public for subscription or purchase of shares or debentures. According to section 2(70) of the Companies Act, 2013 a prospectus is any document as per sections 31 and 32 that invites offers from public for the subscription or purchase of shares or debentures of a body corporate. Generally prospectus includes any document which invites general public to invest in the securities of a company.
The main elements of a prospectus are as follows:
a. There must be an open invitation to general public.
b. The invitation must be made by the company or on behalf of the company.
c. The invitation must be to subscribe for or to purchase its shares or debentures.
ii. SEBI Approval:
SEBI (Securities and Exchange Board of India) regulates the capital market in India in order to protect the interest of the investors. It issues guidelines for disclosure of information. If a company proposes to raise capital from public by issue of shares or debentures, then a draft prospectus has to be submitted to SEBI for its scrutiny to ensure that disclosures made therein are adequate for protection of interest of investors. Prior approval from SEBI is compulsory before going ahead with raising funds from public.
iii. Filing of Prospectus:
A copy of Prospectus has to be filed with the Registrar of Companies.
iv. Appointment of Bankers, Brokers and Underwriters:
Raising funds from the public is a complex procedure.
So in order to ease the process following experts in different fields are appointed:
(a) Merchant bankers of the company to receive the application money.
(b) Brokers to encourage and motivate the public to apply for the shares and distribute the application forms to them.
(c) Underwriters to undertake and promise to buy the shares, if these are not subscribed by the public. They receive a commission for underwriting the issue which is known as underwriting commission.
v. Minimum Subscription:
In order to prevent companies from commencing business with inadequate funds, it is provided that a company must receive the amount of minimum subscription. It refers to minimum number of shares that must be subscribed by the investors before a company proceeds with the allotment of shares.
According to the Companies Act, the minimum subscription should be 90% of the total number of shares offered to the public. If the company receives applications for less than 90% of the size of issue, the application money must be returned to the applicants.
vi. Application to Stock Exchange:
It is necessary for a public company to get its shares listed on a stock exchange. If the company going for a public issue, fails to apply to a stock exchange for permission to deal in its securities or fails to get such permission within 10 weeks from the date of closure of subscription list, the allotment shall become void, and consequently all money received from the applicants will have to be returned to them within 8 days.
vii. Allotment of Shares:
After getting listed in the stock exchange, the company makes allotment of shares as per guidelines of SEBI (Securities Exchange Board of India). Allotment letters are issued to the successful allottees. The company returns the application money to the applicants to whom no shares are allotted. In case the shares allotted are less than shares applied, excess application money is either returned or adjusted towards allotment money.
A return of allotment containing names, addresses of shareholders and number of shares allotted to each share-holder, signed by a director or secretary is filed with the Registrar within 30 days of allotment.
Step # 4. Commencement of Business:
After receiving the minimum subscription on issue of shares, a public company makes an application to the Registrar of Companies for issue of Certificate of Commencement of Business.
An application along with the following documents must be filed:
i. A declaration that minimum subscription requirement has been met.
ii. A declaration that all directors have paid in cash in respect of allotment of shares made to them.
iii. A declaration that no money is liable to become refundable to the applicants because of failure to obtain permission for shares to be traded in a recognised stock exchange.
iv. A statutory declaration by a Director or the Secretary of the company stating that the requirements relating to the commencement of business have been duly complied with.
Relevance of Certificate of Commencement of Business:
The Registrar examines all the documents filed and if he finds them satisfactory, a ‘Certificate of Commencement of Business’ is issued. The grant of this certificate completes the process of formation of a company. The company can start its business activities from the date of issue of the certificate. It is the conclusive proof that a company is entitled to do business. The business must be according to the objects laid down in the objects clause of the Memorandum of Association.
Company Formation – Formation of a Private Company and Public Company (with Stages)
The stages involved in formation of a company outline below:
A. Stages in Formation of a Private Company:
1. Promotion
2. Incorporation
B. Stages in Formation of a Public Company:
1. Promotion
2. Incorporation
3. Subscription of capital
1. Promotion of a Company:
Promotion is the first stage in the formation of a company. It involves conceiving a business opportunity and taking an initiative to form a company, so that a practical shape can be given to the available business opportunity.
Any person or a group of persons or even a company are said to be the promoters of the company. They conceive the business idea, decide to form a company, take necessary steps for the same and assume associated risks.
As per section 69, a promoter means a person:
i. Who has been named as such in a prospectus or is identified by the company in the annual return referred to in section 92; or
ii. Who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
iii. In accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act.
iv. However, it is provided that nothing in this sub clause shall apply to a person who is acting merely in a professional capacity.
They are neither the agents nor the trustees of the company. They are personally liable for all the contracts which are entered by them, for the company before its incorporation, in case the same are not ratified by the company later on. Promoters of a company enjoy a fiduciary position with the company, which they must not misuse. They can make a profit only if it is disclosed but must not make any secret profits.
In the event of a non-disclosure, the company can rescind the contract and recover the purchase price paid to the promoters. Promoters are not legally entitled to claim the expenses incurred in the promotion of the company. However, the company may choose to reimburse them for the pre-incorporation expenses, remunerate them for their efforts by paying a lump sum amount or a commission on the purchase price of property purchased through them or on the shares sold, allot those shares or debentures or give them an option to purchase the securities at a future date.
For example, a syndicate of three persons namely, Akanksha, Ann and Devesh was formed to purchase the Tech Solutions Company and to promote and register a company to which the Tech Solutions Company property was to be resold. At that time the Tech Solutions Company was in a bad shape. The syndicate first bought the debentures of the Tech Solutions Company at a discount.
Then they brought the company for Rs.44,00,000. Out of this money, provided by them, the debentures were repaid in full and a profit of Rs.40,000 was made thereon. They promoted a new company and sold Tech Solutions Company to it for Rs.54,00,000. The profit of Rs.10,00,000 was revealed in the, prospectus, but not the profit of Rs.40,000. It was held that the profit of Rs.40,000 was a secret profit made by the syndicate as promoters of the company.
In the above case Akanksha, Ann and Devesh have made a secret profit of Rs.40,000. The promoters can make a profit only if it is disclosed but must not make any secret profits.
(Fiduciary relationship means where one person places complete trust in another in regard to a particular transaction or one’s general affairs or business. The relationship is not necessarily formally or legally established as in a declaration of trust, but can be one of moral or personal responsibility, due to the superior knowledge and training of the fiduciary as compared to the one whose affairs the fiduciary is handling.)
In the event of a non-disclosure, the company can cancel the contract and recover the purchase price paid to the promoters. It can also claim damages for the loss suffered due to the non-disclosure of material information.
The various functions of a promoter are described:
i. Identification of Business Opportunity:
Without the identification of an opportunity a promoter will have nothing to peruse as a proposal. A lucrative business idea may relate to producing a new product or service or making some product available through a different channel or any other opportunity having an investment potential.
ii. Feasibility Studies of Different Types may be Undertaken:
Technical feasibility is said to favourable if the required raw material or technology is easily available. Financial feasibility is said to favourable if the required funds can be easily be arranged within the available means. Economic feasibility is said to favourable if the chance of proposal being profitable is very high.
Shridhar is planning to promote an e-commerce company. At a conceptual level the offering is highly simple, but at the technology level it is immensely complicated. For example, a planned itinerary for a ten day trip to Paris will have a trillion possibilities and the number of permutations.
The success of the business will depend upon its ability to churn out plans based on logic and according to preference within seconds. With the help of a business planner he has determined that the capital investment can be arranged within the available means. Moreover, he has analysed that the level of competition in this segment is high.
a. Technical feasibility – “At a conceptual level the offering is highly simple, but at the technology level it is immensely complicated.”
b. Financial feasibility – “He has determined that the capital investment can be arranged within the available means.”
c. Economic feasibility – “Moreover, he has analysed that the level of competition in this segment is high.”
iii. Name Approval:
The promoters have to select a name for the proposed company. He has to submit, an application to the registrar of companies of the state in which the registered office of the company is to be situated, for its approval. He will have to give three names, in order of his priority have to be given in the application to the registrar of companies, performa application for availability of names (form la).
The proposed name of the company likely to be rejected in the following cases:
a.If it is identical with or too closely resembles the name of an existing company
b. If it is misleading. It is so considered, if the name suggests that the company is in a particular business or it is an association of a particular type when it is not true
c. If it is violative of the provisions of The Emblem and Names (Prevention of Improper Use) Act 1950, as given in the schedule to this Act. The Act also prohibits use of any name which may suggest patronage of Government of India, or any state government or any local authority
iv. Fixing up Signatories to the Memorandum of Association:
Before the incorporation of the company it is essential to fix up Signatories to the Memorandum of Association. Also, their written consent to act as Directors and to take up the qualification shares in the company is taken.
v. Appointment of Professionals:
The promoter has to appoint professionals such as mercantile bankers, auditors etc. The expert services of these professionals is required in the preparation of necessary documents which are required to be with the registrar of companies for registration.
vi. Preparation of Necessary Documents:
The promoter is required to get certain legal documents prepared i.e. Memorandum of Association, Articles of Association and Consent of Directors. The submission of these documents is mandatory to the Registrar of the Companies for getting the company registered.
Documents to be prepared by the promoters for incorporation:
i. Memorandum of Association:
Memorandum of Association defines the objects for which the company is formed. This is the main document of the company and is subordinate to the Companies Act. Memorandum of Association defines the relationship of the company with outsiders.
Acts beyond the Memorandum of Association are invalid and cannot be ratified even by a unanimous vote of the members. Every company has to file a Memorandum of Association. It contains different clauses namely; Name clause, Registered office clause, Objects clause, Liability clause, Capital clause and Association clause.
ii. Articles of Association:
It states the rules regarding internal management of a company. A public limited company may adopt table F which is a model set of articles given in the companies act.
iii. Consent of Proposed Directors:
The proposed directors have to give in writing their confirmation stating that they agree to act in that capacity and undertake to buy and pay for qualification shares, as mentioned in the Articles of Association.
iv. Agreement:
The company may propose to enter with any individual for appointment as its Managing Director or a whole time Director or Manager. If it does so it is required to be submit another document to the Registrar for getting the company registered under the Act.
v. Statutory Declaration:
The promoter has to submit a statutory to the Registrar with the above mentioned documents for getting the company registered under the law. The statutory declaration states that all the legal requirements pertaining to registration have been complied with is to be submitted. This declaration can be signed by an advocate of High Court or Supreme Court or by a Chartered Accountant in full time practice or by a person named in the articles as a director or manager or secretary of the company.
a. In order to get a company registered it is necessary to pay certain amount of fees.
b. The amount of such fees shall depend on the authorised share capital of the company.
2. Incorporation:
Incorporation is the second stage in formation of a company. Both a Private company and a Public company has to go through this stage.
In order to get a company registered the application is to be filed with the Registrar of Companies of the state within which the registered office of the company is to be established accompanied with following documents –
As per section 2(56) of the Companies Act, 2013 “memorandum” means the Memorandum of association of a company as originally framed from time to time in pursuance of any previous company law or of this act.
The various clauses of memorandum of association are outlined below:
a. Name clause – It contains the name of the company which has already been approved by the Registrar of Companies.
b. Registered office clause – It contains the name of the state, in which the registered office of the company is proposed to be situated. The exact address of the registered office is not required at this stage but the same must be notified to the Registrar within thirty days of the incorporation of the company.
c. Objects clause – It defines the purpose for which the company is formed and a company is not legally entitled to undertake an activity, which is beyond the objects stated in this clause.
The object clause is divided into two sub clauses, which are:
(a) Main Objects;
(b) Objects considered necessary in furtherance of the main objects.
d. Liability clause – This clause restricts the liability of the members only to the extent of amount unpaid on the shares owned by them. For example if Jay is holding 100 shares of Rs.10 each of a company. He has already paid Rs.8 per share and only Rs.2 per share is unpaid. In this case his liability is limited to Rs.200 only (100 x Rs.2).
e. Capital clause – It specifies the maximum capital which the company will be authorised to raise through the issue of shares. The authorised share capital of the proposed company along with its division into the number of shares having a fixed face value is specified in this clause.
f. Association Clause – It contains the signatories to the Memorandum of Association who have stated their intention to be associated with the company and also give their consent to purchase qualification shares. It must be signed by at least seven persons in case of a public company and by two persons in case of a private company.
It contains the rules regarding internal management of a company. These rules are subsidiary to the Memorandum of Association and hence, should not contradict or exceed anything stated in the Memorandum of Association.
According to section 2(5) of The Companies Act, 2013, ‘articles’ means the article of association of a company as originally framed or as altered from time to time or applied in pursuance of any previous company law or of this Act. The articles of a company shall be in respective forms as specified in Table F, G, H, I and J in schedule I as may be applicable to such company
However, the companies are free to make their own articles of association which may be contrary to the clauses of Table F, G, H, I, J and in that case articles of association as adopted by the company shall apply.
iii. Consent of Proposed Directors:
The consent of proposed directors is required in writing so as confirm that they agree to act in that capacity and undertake to buy and pay for qualification shares, as mentioned in the Articles of Association.
The company may propose to enter with any individual for appointment as its Managing Director or a whole time Director or Manager. If it does so it is required to be submit another document to the Registrar for getting the company registered under the Act.
The promoter has to submit a statutory to the Registrar with the above mentioned documents for getting the company registered under the law. The statutory declaration states that all the legal requirements pertaining to registration have been complied with is to be submitted. This declaration can be signed by an advocate of High Court or Supreme Court or by a Chartered Accountant in full time practice or by a person named in the articles as a director or manager or secretary of the company.
In order to get a company registered it is necessary to pay certain amount of fees. The amount of such fees shall depend on the authorised share capital of the company.
The Memorandum of Association for the two proposed companies cannot be same. No, two companies can file an exactly same Memorandum of Association because at least the Name clause is ought to be different. This is because two different companies cannot be registered with the same name.
Whereas, it is not necessary for every company to prepare separate Articles of Association. Articles of Association are the rules regarding internal management of a company. A public limited company may adopt Table F which is a model set of articles given in the Companies Act.
Table F is a document containing rules and regulations for the internal management of a company. For companies not adopting Table F, a copy of the Articles of Association, stamped and duly signed by signatories to the Memorandum of Association is required for registration.
Documents Required for the Incorporation of a Company:
The application is to be filed with the Registrar of Companies of the state within which the registered office of the company is to be established accompanied with following documents about –
i. The Memorandum of Association duly stamped, signed and witnessed by at least seven members in case of a public company but for a private company however the signatures of two members are sufficient. The signatories must also give information about their address, occupation and the number of shares subscribed by them.
ii. The Articles of Association duly stamped and witnessed as in case of the Memorandum.
iii. Written consent of the proposed directors to act as directors and an undertaking to purchase qualification shares.
iv. The agreement, if any, with the proposed Managing Director, Manager or whole-time director.
v. A copy of the Registrar’s letter approving the name of the company.
vi. A statutory declaration affirming that all legal requirements for registration have been complied with. This must be signed by an advocate of a High court or Supreme Court or a signatory to the Memorandum of Association or a Chartered Accountant or Company Secretary in whole time practice in India.
vii. A notice about the exact address of the registered office may also be submitted along with these documents. However, if the same is not submitted at the time of incorporation, it can be submitted within 30 days of the receipt of the certificate of incorporation.
viii. Documentary evidence of payment of registration fees.
Effects of the ‘Certificates of Incorporation’:
A company is legally born on the date printed on the Certificate of Incorporation. The Certificate of Incorporation is a conclusive evidence of the regularity of the incorporation of a company. A company is legally born on their date which is mentioned on the Certificate of Incorporation irrespective of the date on which the certificate was insured.
For example, if the documents for registration were filed on 4th April 2017 with the Registrar of the companies. The contracts signed by the company on 4th April 2017 will be considered valid even if the company secures the Certificate of Incorporation on 6th April 2017.
Moreover, once a Certificate of Incorporation has been issued, the company has become a legal business entity irrespective of any flaw in its registration.
Also, even if the memorandum of association contained forged signatures the incorporation will still be valid. For example, Dharvi started an export business in the form of a private company along with her uncles Mr. Danush Kumar and Mr. Manush Kumar. Later on, she came to know that Mr. Manush Kumar had forged the signatures of Mr. Danush Kumar on the Memorandum of Association, as he was not available at the time of filling the document.
She is now fearing that the Incorporation of the company will be considered invalid. However, this may not be true. Even if a person forged the signatures of others on the Memorandum of Association the Incorporation was still considered valid. Thus, whatever be the deficiency in the formalities, the Certificate of Incorporation once issued, is a conclusive evidence of the existence of the company.
The contracts that promoters may enter into with third parties on behalf of the company during the promotion of the company are called preliminary contracts or pre-incorporation contracts.
Preliminary contracts are not legally binding on the company. A company thus cannot be forced to honour a preliminary contract. The promoters remain personally liable on a contract made on behalf of a Company which is not yet in existence. Such a contract is deemed to have been entered into personally by the promoters and they are liable to pay damages for failure to perform the promises made in the Company’s name.
For example, Ranger Private Ltd. was in the process of incorporation. The Promoters of the Company signed an agreement for the purchase of ten computers for the Company and payment was to be made to the suppliers of the computers by the Company after incorporation. The company was incorporated and the computers were used by it.
Shortly after incorporation, the company went into liquidation and the debt could not be paid by the company for the purchase of the computers. As a result, suppliers sued the promoters of the company for the recovery of money. In this case, the promoters continue to be held liable.
Note – There is no provision for Provisional Contract under the Companies Act, 2013.
3. Capital Subscription:
On the issue of the Certificate of Incorporation, a private company can immediately go through Capital Subscription is the third stage in formation of a company. Only a Public company has to go through this stage.
The steps involved at this stage are as follows:
i. Securities and Exchange Board of India (SEBI) Approval:
It is must for a public company to get the approval from SEBI prior to going ahead with raising funds from public in order to protect the interest of the investors. The company has to make adequate disclosure of all relevant information for this.
ii. Filing of Prospectus:
A copy of the prospectus or statement in lieu of prospectus is filed with the Registrar of Companies. A prospectus is ‘any document described or issued as a prospectus including any notice, circular, advertisement or other document inviting deposits from the public or inviting offers from the public for the subscription or purchase of any securities of, a body corporate’.
The statements in the prospectus are legally binding on the company therefore, there must not be a mis-statement in the prospectus and all material important information must be fully disclosed.
iii. Appointment of Bankers, Brokers, Underwriters:
The company needs to appoint bankers, brokers, underwriters for carrying out different types. The bankers of the company are responsible for receiving the application money. Whereas, the brokers encourage the sale of the shares by distributing the forms and persuading the public to apply for the shares. The underwriters undertake to buy the shares if these are not subscribed by the public.
iv. Minimum Subscription:
According to the Companies Act, the limit of minimum subscription is 90 per cent of the size of the issue. Therefore, if applications received for the shares are for an amount less than 90 per cent of the issue size, the allotment cannot be made and the application money received must be returned to the applicants.
v. Application to Stock Exchange:
The listing of securities at stack exchange(s) is essential to promote the liquidity and marketability. Therefore, the company needs to file an application at least one stock exchange for permission to deal in its shares or debentures. If such permission is not granted before the expiry of ten weeks from the date of closure of subscription list, the allotment shall become void and all money received from the applicants will have to be returned to them within eight days.
vi. Allotment of Shares:
The shares are allotted to the investors in accordance to subscription received for them. In case the number of shares allotted is less than the number applied for, or where no shares are allotted to the applicant, the excess application money if any, is to be returned to applicants or adjusted towards allotment money due from them. Return of allotment, signed by a director or secretary is filed with the Registrar of Companies within 30 days of allotment.
Minimum Subscription:
According to the Companies Act, the limit of minimum subscription is 90 per cent of the size of the issue. Therefore, if applications received for the shares are for an amount less than 90 per cent of the issue size, the allotment cannot be made and the application money received must be returned to the applicants.
A prospectus is ‘any document described or issued as a prospectus including any notice, circular, advertisement or other document inviting deposits from the public or inviting offers from the public for the subscription or purchase of any shares or debentures of, a body corporate’.
The Articles usually have a provision requiring directors to buy a certain number of shares before the company obtains Certificate of Commencement of Business to ensure that they have some stake in the proposed company are called Qualification Shares.
Statement in Lieu of Prospectus:
In case a public company decides to raise the funds through friends, relatives or some private arrangements as done by a private company instead of inviting public to subscribe to its shares or debentures, there is no need to issue a prospectus. Instead a ‘Statement in Lieu of Prospectus’ is filed with the Registrar at least three days before making the allotment.
A company is legally born on the date printed on the Certificate of Incorporation. The Certificate of Incorporation is a conclusive evidence of the regularity of the incorporation of a company. Once a Certificate of Incorporation has beenu issued, the company has become a legal business entity irrespective of any flaw in its registration. On the issue of Certificate of Incorporation, a private company can immediately commence its business.
According to The Companies Act, whenever a company having a share capital makes any allotment of its securities, the company shall, within thirty days thereafter, file with the Registrar a return of allotment, along with the requisite fee.
The Factors that Determine the Choice of form of Organisation:
The choice of form of business organisation is influenced by a multiplicity of factors as each form of organisation has certain advantages as well as disadvantages. It, therefore, becomes vital that certain basic considerations are kept in mind while choosing an appropriate form of organisation.
The important factors determining the choice of organisation are discussed below:
i. Cost and Ease in Setting up the Organisation:
Sole proprietorship is the most inexpensive way of starting a business, as the legal requirements are minimum and the scale of operations is small. Likewise, in case of partnership too, there are less legal formalities and cost because of limited scale of operations. The formation of cooperative societies and companies require compulsorily registration, which involves a lengthy and expensive legal procedure.
ii. Liability:
In case of sole proprietorship and partnership firms, the liability of the owners/partners is unlimited and the debt may have to be settled from personal assets of the owners in case the assets of business are insufficient. In joint Hindu family business, only the liability of karta is unlimited whereas coparceners have limited liability.
In cooperative societies and companies the liability of the members is limited. Therefore, the company form of organisation is more suitable from the point of view of investors, as the risk involved is limited.
iii. Continuity:
The continuity of sole proprietorship and partnership firms is affected by such events as death, insolvency or insanity of the owners. Whereas joint Hindu family business, cooperative societies and companies are more stable form of organisations.
iv. Management Ability:
The nature of operations and the need for professionalised management affect the choice of the form of organisation. Sole proprietorship or partnership are considered to be suitable, where operations are simple and even people with limited skills are able to run the business. Whereas, if the organisation’s operations are complex in nature professionalised management is required, company form of organisation is a better alternative.
v. Capital Considerations:
If the scale of operations is large, company form may be suitable as it is in a better position to collect large amounts of capital by issuing shares to a large number of investors. Whereas, for medium and small sized business sole proprietorship or partnership are considered to be suitable as the resources available to them are limited.
vi. Degree of Control:
Sole proprietorship form of business may be preferred if direct control over operations and absolute decision making power is required. Whereas, in partnership or company form of organisation control and decision making process are shared. Moreover, professionals are appointed to independently manage the affairs of a company, as there is complete separation of ownership and management
vii. Nature of Business:
Sole proprietorship may be more suitable, if direct personal contact is needed with the customers such as in the case of a grocery store. On contrary, for large manufacturing units the company form of organisation may be adopted as direct personal contact with the customer is not required. Partnership form of organisation is much more suitable in cases where services of a professional nature are required.