COMMERCE STD. XI (ISC) Chapter 9: Formation of a Company 28-08-2018 Formation of a company involves various stages: i) Promotion ii) Incorporation iii) Floatation or Capital subscription iv) Commencement of business Promotion It is the discovery of business opportunities, its investigation and assembling of necessary resources to set up a business as a profitable concern. It is the discovery of business idea and the subsequent organization of funds, property and management ability into the business, for the purpose of making profit thereon. Stages in Promotion 1) Discovery of business idea: The business opportunity may be related to a new idea or taking over an existing undertaking. At this stage, a preliminary analysis is also made to ensure that the idea deserves a detailed investigation. 2) Detailed investigation: Once the idea is conceived, it should be further investigated to check it technical, financial and commercial feasibility. Detailed investigation involves study of market demand, factors of production, degree of potential competition, probable sales and profits etc. After the investigation is completed, the findings are presented in a type-written report, known as project report or feasibility report. It helps in judging whether the proposition will yield the fair return on the investment and for the risks undertaken. It also helps in setting Business Plan. 3) Assembling: Once the promoter is convinced with the feasibility of the proposition, he takes steps to assemble the necessary resources like plants & machinery, tools, factory site, make contracts with the suppliers, acquires patents & trade-marks, human resource etc. 4) Financing of proposition: At this stage, financial plans are prepared with respect to capitalization, capital structure, time & method of capital issue etc. The business proposition is presented to the public in the form of Prospectus. Agreements are made with underwriters, stock brokers, bankers etc. Promoters & types A promoter may be an individual, firm or a company who transforms an idea into business capable of yielding a profit, who brings together physical, financial and human resources and takes necessary steps to bring the new business into existence. They are many types of promoters: 1) Professional promoter: They are specialized agencies and promotion is their whole time occupation. As specialists in forming new business ventures, they promote business enterprises and hand over the management 1
of such companies to their owners or shareholders. 2) Accidental / Occasional promoters: They promote their own firms as entrepreneurs. They own and manage the enterprise promoted by them. They are not specialist and promotion is not their whole-time job. 3) Financial / Investment promoters: They float new enterprises during favorable conditions in the securities market. They are mainly interested in making gains from favorable investment climate in the economy. 4) Technical promoters: These promoters promote new enterprises on the basis of their specialised knowledge and training in technical fields. They charge fees for their services. Technicians, consultants and engineers may also promotes enterprise to make commercial use of their invention. 5) Specialised institutions: Specialised institutions like IDBI provide technical, managerial and financial assistance for the promotion of new enterprise. They collaborate with other entrepreneurs to launch new enterprises. 6) Government: The government of India has emerged as a big promoter of industrial and commercial undertakings. Incorporation of a company A company being an artificial person comes into existence through incorporation. Incorporation implies the registration of the company as a body corporate with the Registrar of Companies. It is the legal process through which an enterprise becomes an artificial legal entity. It consists of following steps: 1) Approval of name: The proposed name of the company should be approved with the Registrar of Companies. For this purpose, an application is made to the registrar. 2) Filing of documents: An application in the prescribed form along with the following documents should be submitted to the Registrar of the Companies Memorandum of Association duly signed and stamped by atleast seven persons in case of a public company and two in case of a private company Articles of Association duly signed and stamped by the signatories of MOA. A private company must file its own AOA. A public company may not prepare its own AOA, and may adopt Table A in Schedule I of The Companies Act. A List of directors with their full names, addresses, ages and occupations. In case such a list is not files, subscribers to the MOA will be deemed to be the directors. Written consent of the persons who have agreed to act as first directors of the company, along with the written undertaking to take and pay for the qualification shares. A private company and a company without share capital need not file this document. A copy of the letter from the Registrar in which the name of the company was approved. Notice of the address of the registered office of the company. However, this notice may be filed within 30 days of the date of incorporation. The agreement, if any, which the company proposes to enter into with any individual for appointment of as its managing or whole time director or manager. Statutory declaration stating that all the requirements necessary for registration have been complied with. This declaration may be signed by an advocate of the Supreme Court or a High Court or a CA/CS practicing in India etc. 3) Payment of fees: along with the above documents, the company must pay the prescribed filing fees, stamp duty and registration fees. The amount of registration fees varies according to the amount of authorized capital. 2
4) Registration: The Registrar of the companies will carefully scrutinize the documents filed by the company. If he is satisfied that all the requirement have been met, he will enter the name of the company in his register. 5) Certificate of Incorporation: After registration, the registrar will issue a certificate to the company. This certificate is called The Certificate of Incorporation. It is dated and signed by the registrar. On the date mentioned on this certificate, the company becomes a distinct legal entity with perpetual succession and a common seal. Along with this certificate, the Registrar also issues a Corporate Identity Number (CIN) to the company. Commencement of Business A private company can start its business immediately after receiving the Certificate of Incorporation but a public company having share capital and issuing a prospectus cannot start its business immediately after incorporation. It must obtain a Certificate of Commencement of business. In order to obtain this certificate, the company must file with the Registrar of Companies the following documents: 1) A declaration that shares payable in cash have been allotted equal to an amount not less than the minimum subscription and that such cash has actually been received from shares allotted for cash. 2) A declaration that a prospectus or a statement in lieu of prospectus has been filed with the registrar. 3) A declaration that the directors have taken up their qualification shares and that they have paid in cash the application and allotment money on the shares held by them in the same proportion as others. 4) A declaration that no money is liable to become refundable to the applicants by reason of failure to apply for or to obtain permission for shares or debentures to be dealt in on any recognized stock exchange. 5) A statutory declaration in the prescribed form duly verified by a director or secretary of the company stating that the requirements relating to the commencement of business have been duly complied with. The Registrar of Companies will scrutinize these documents and if satisfied that all the formalities are complied with, he shall issue a Certificate of Commencement of Business. The public company becomes entitled to start its business with effect from the date mentioned in this certificate. Memorandum of Association It defines the objects and powers of a company and the company s relationship with the outside world. It is a charter of a company and defines the limitations of the powers of the company. It serves as a foundation on which the structure of the company is built Its purpose is to enable the shareholders, creditors and others who deal with the company to know its permitted range of activities. Any act of the company beyond the powers mentioned in the Memorandum is said to be ultra-vires, and therefore not binding on the company. Memorandum should be printed, divided into paragraphs, numbered consecutively, signed by each subscriber (2 in case of private company and 7 in case of a public company) and duly attested by a witness. MOA is a public document and its copies have to be supplied upon request on payment of a nominal charge. Contents of Memorandum 1) The Name Clause: This clause contains the name of the company. The name must appear on the outside of every office, or place of business, in a conspicuous manner in one of the local language and on all cheques, bills, letters, notices and all other official papers and publications of the company. The name should also be engraved on the seal of the company. The following conditions apply while choosing the name of the company: The proposed should not be identical or similar to the name of an existing company. 3
The proposed name should not convey any connection or link with the government department or local authority as it is undesirable and may mislead the public. The name of the public company limited by shares should end with the word limited while private company should contain the words private limited The proposed name should not be objectionable. 2) The Situation / Domicile Clause: This clause specifies the name of the State in which the registered office of the company is to be situated. This is necessary to determine the domicile of the company. There is no statutory binding to give the exact address of the registered office in the MOA, but it is beneficial to do so, as all important notices, circulars are sent there. Moreover, important documents like Register of Members, Register of Debenture-holders, minutes etc. are kept there. 3) The Object Clause: This is considered as the core of the MOA because it defines the powers of the company and the scope of its activities. A company is not authorized to do any business outside the scope of objects clause. From this clause, shareholders and creditors can find out the purpose for which their money is utilized. A company can make alterations in the objects clause only with the approval of the Central government and after going through the legal formalities. The objects of the company must not be against the provisions of The Companies Act and against the public policy. The objects of the company must not be illegal, immoralor fraudulent. The objects clause must be divided into: The main objects of the company and objects incidental or ancillary to the attainment of the main objects. Other objects of the company which are not included above. 4) The Liability Clause: This clause states that the liability of members is limited to the amount, if any, unpaid on the shares held by them. In case of companies limited by guarantee, they need to mention the guaranteed amount which shareholders have agreed to pay at the time of winding up. The MOA may provide for unlimited liability of directors. A company registered with unlimited liability is not required to give this clause in its MOA. 5) The Capital Clause: This clause states the authorized share capital with which the company is registered. Number and types of shares are also mentioned under this clause. Every limited company with share capital is required to give this clause but an unlimited company having a share capital need not. 6) The Subscription / Association Clause: This clause contains the full names, occupations and addresses of subscriber to the MOA. The subscribers make a declaration under their signatures duly attested by witness that they desire to be formed into a company and agree to take qualification shares if any. There must be atleast 7 signatories in case of public company and atleast 2 in case of a private company. Articles of Association It contains the rules and regulations relating to the management of its internal affairs. They define the rights, powers and duties of the management, the mode and manner in which the business of the company is to be carried on. AOA shows the relations between the company and its members and between members and members. AOA must not contain anything which is against the MOA or against The Companies Act or public policy. Articles are subsidiary to memorandum. AOA must be printed, divided into paragraphs, numbered consecutively and signed by each signatory to the MOA in the presence of at least one attesting witness. 4
A public company limited by shares may register its own AOA or it may adopt Table A given in Schedule I of the Companies Act. A company limited by guarantee without having share capital may file its own AOA or it may adopt Table C. A company limited by guarantee and having share capital may adopt Table D An unlimited company may adopt Table E. Prospectus A prospectus is a document and includes a notice, circular, advertisement or other document inviting the public to provide funds to the company by way of deposits or subscriptions to its shares and debentures. It is a valuable document containing important details about a company. It should be dated and signed by every directors of the company. A copy of it must be filed with the registrar before it is issued to the public. A prospectus must disclose all the required information with full accuracy. Any omission, concealment, misstatement of a material fact in the prospectus may render it to be false and misleading. Applicants who have applied for shares on the faith of a false prospectus may rescind the allotment of shares. They can also claim damages from the same. The directors and other officers involved in the issue of prospectus may be held personally liable for damages and punishment. Statement in lieu of prospectus A public company having share capital need not file and publish a prospectus if it wants to raise its capital privately without public notice. In such a case, it must file a statement in lieu of prospectus with the Registrar of companies at least three days before the allotment of shares. It must be duly signed by all the directors. It should be dated and should indicate when it was delivered to the registrar. A private company is not required to either file a prospectus or a statement in lieu of prospectus with the Registrar of Companies. All the provisions of the Companies Act which are applicable to prospectus with regard to registration, alteration, liability for untrue statements etc, are equally applicable to a statement in lieu of prospectus as well. Minimum subscription A company making any public or rights issue of shares or debentures cannot make allotment of the shares or debentures unless it has received a minimum subscription against the proposed issue of securities. The word minimum refers to the nominal amount of shares applied for and not to the amount payable on application. According to SEBI guidelines 90% subscription against an issue must be received before making the allotment of securities to the public. If the minimum subscription is not received within 120 days of the issue of prospectus, the amount received on applications must be refunded to the applicants within the next 10 days. The purpose of the rule is to ensure that no company begins its business without obtaining the minimum amount of money required to meet the initial expenses and working capital. The amount of minimum subscription is fixed by the directors. It is necessary to cover the following requirements of: Preliminary expenses Underwriting expenses Working capital The cost of any property, purchased or to be purchased Payment of any money borrowed for the above purpose Any other necessary expenditure 5
Preliminary expenses Preliminary expenses are incidental to the formation of a company. These are treated as fictitious assests and written off over a period of time. It includes the following expenses: Cost of preparing and printing the MOA and AOA Cost of preparing, printing and circulating the prospectus Cost of registering the company (filing of documents, stamp duty and fee, etc.) Cost of preliminary agreements Cost of preparing and printing application forms, letters of allotment and share certificates Fees of valuers for reports, certificates etc. Extra Questions Q1 What are the functions performed by a promoter? Q2 A promoter has a fiduciary relationship with the company. With reference to this statement, state the liabilities of a promoter. Q3 Why is Memorandum the most essential document for a company? Q4 State the restrictions of a private company which should be mentioned in AOA. Q5 List any 8 contents of Articles of Association. Q6 Differentiate between MOA and AOA. Q7 Q8 Mention any 8 contents of the prospectus. Give the importance of issuing prospectus. INSTRUCTIONS TO STUDY THIS CHAPTER: Please read your book for detailed information of the above topics. The length of the answer depends on the marks in the question paper and may not only be substituted with what is mentioned in the notes. Examples can be used to elaborate your points for this chapter. 6