Introduction to Formation of a Company

Modern business requires substantial capital and faces increasing competition and technological changes, which raise risks. Consequently, the company form of organisation is preferred for medium and large businesses.

The process from conceiving a business idea to legally starting a company is called the stages in the formation of a company. The individuals undertaking these steps and risks are called promoters.

This chapter explains the stages in company formation and the necessary steps in each stage.

Example: Avtar, an automobile engineer, developed a carburettor that reduces petrol consumption by 40%. He wants to produce it on a large scale and needs significant funds. He considers different business forms and decides to form a company due to the large funds and risks involved.

Formation of a Company

Formation of a company involves legal formalities and procedures divided into three stages:

• Promotion
• Incorporation
• Subscription of Capital

Note: Private companies cannot raise funds from the public and do not issue a prospectus or require minimum subscription.

Promotion of a Company

Promotion is the first stage where a business idea is conceived and steps are taken to form a company to exploit the opportunity.

Promoters: Persons or groups who initiate the company formation and take necessary steps. They analyse prospects, assemble resources, and set the organisation going.

Legal Definition (Section 69): A promoter is a person who:

• Is named in the prospectus or identified in the annual return;
• Has control over company affairs directly or indirectly;
• Gives advice or instructions to the Board of Directors (except in professional capacity).

Functions of Promoters:

1. Identification of Business Opportunity: Recognising potential business ideas with investment potential.
2. Feasibility Studies: Assessing technical, financial, and economic viability with expert help.

Technical Feasibility: Availability of raw materials and technology.

Financial Feasibility: Estimating fund requirements and availability.

Economic Feasibility: Profitability prospects.

3. Name Approval: Applying to Registrar of Companies for company name approval, submitting three priority names.
4. Fixing Signatories to Memorandum of Association: Deciding members who will sign the Memorandum and act as first directors.
5. Appointment of Professionals: Hiring bankers, auditors, etc., to assist in document preparation.
6. Preparation of Documents: Preparing Memorandum of Association, Articles of Association, and consent of directors.

Name Clause - Undesirable Names:

• Identical or similar to existing company names.
• Misleading about business nature.
• Violating The Emblem and Names (Prevention of Improper Use) Act, 1950.

Documents Required for Registration

A. Memorandum of Association (MOA): Defines company objectives and legal scope.

• Name Clause: Approved company name.
• Registered Office Clause: State of registered office; exact address to be notified within 30 days of incorporation.
• Objects Clause: Purpose of company formation; activities beyond this are invalid.
• Liability Clause: Limits members' liability to unpaid share amount.
• Capital Clause: Maximum authorised share capital and division into shares.

MOA must be signed by at least seven persons for public companies and two for private companies.

B. Articles of Association (AOA): Rules for internal management, subsidiary to MOA, must not contradict MOA.

Companies may adopt standard forms (Table F to J) or create their own articles.

C. Consent of Proposed Directors: Written consent to act as directors and undertake qualification shares.

D. Agreement: Agreement with Managing Director or whole-time director, if any.

E. Statutory Declaration: Declaration of compliance with legal requirements, signed by qualified professionals or company officers.

F. Receipt of Payment of Fee: Registration fees based on authorised share capital.

Qualification Shares: Directors must buy shares before commencement of business to have a stake in the company.

Contents of Articles of Association: Includes share details, allotment, calls, transfer, meetings, directors, audit, dividends, winding up, and more.

Position of Promoters

Promoters are personally liable for contracts made before incorporation unless ratified by the company. They hold a fiduciary position and must disclose profits. They are not entitled to claim promotion expenses unless reimbursed by the company.

Incorporation

After promotion, promoters apply to the Registrar of Companies with required documents and fees.

Documents include:

• Memorandum of Association signed by required members.
• Articles of Association or statement in lieu of prospectus.
• Consent of proposed directors.
• Agreement with managing personnel.
• Registrar's name approval letter.
• Statutory declaration of compliance.
• Notice of registered office address.
• Proof of registration fee payment.

Registrar issues Certificate of Incorporation upon satisfaction, which is the company's birth certificate and conclusive evidence of legal existence.

Registrar also allots Corporate Identity Number (CIN).

Preliminary Contracts

Contracts made by promoters before incorporation are not binding on the company unless it enters into fresh contracts. Promoters remain personally liable.

Effect of Certificate of Incorporation

Company becomes a legal entity with perpetual succession and can enter valid contracts from the date on the certificate.

Examples:

• Certificate dated earlier than actual issue date validates contracts from that date.
• Forgery in documents does not invalidate incorporation.

Certificate is conclusive evidence of existence; defects can only be challenged by winding up.

Companies must obtain certificate for commencement of business within 180 days of incorporation.

Director Identification Number (DIN)

Individuals intending to be directors must apply for DIN from Central Government. Only one DIN per individual is allowed.

Capital Subscription

Public companies raise funds from the public by issuing securities and must follow these steps:

1. SEBI Approval: Regulatory approval ensuring investor protection and disclosure.
2. Filing Prospectus: Invitation document filed with Registrar containing all material information.
3. Appointment of Bankers, Brokers, Underwriters: To manage subscription and sale of shares.
4. Minimum Subscription: At least 90% of issue size must be subscribed; otherwise, money is refunded.
5. Application to Stock Exchange: For permission to list securities.
6. Allotment of Shares: Shares allotted, excess money refunded or adjusted, allotment letters issued, and return of allotment filed.

One Person Company (OPC)

Introduced by Companies Act, 2013, OPC allows a single natural person (Indian resident) to form a company enjoying benefits of private limited company.

Characteristics:

• Only one Indian resident natural person can incorporate or be nominee.
• No minor can be member or nominee.
• Cannot carry out non-banking financial investment activities.
• Cannot convert into other company types before two years unless thresholds exceeded.

Summary

Company formation involves:

• Promotion: Identifying opportunity, conducting feasibility studies, name approval, fixing signatories, appointing professionals, and preparing documents.
• Incorporation: Filing application with Registrar, submitting documents and fees, and obtaining Certificate of Incorporation.
• Capital Subscription: For public companies, raising funds through SEBI approval, prospectus filing, appointing intermediaries, ensuring minimum subscription, allotment, and listing.

Preliminary contracts by promoters are not binding unless ratified. Promoters have fiduciary duties and personal liabilities before incorporation.