Chapter 7

Formation of a Company

One can divide the formalities into three distinct stages:

(i) Promotion
(ii)Incorporation
(iii) Subscription of capital

Promotion of a Company

● Promotion is the first stage in the formation of a company.

● It involves conceiving a business idea and taking an initiative to form a company so
that practical shape can be given to exploiting the available business opportunity.
● Thus, it begins with somebody having discovered a potential business idea.

Promoters

● Any person or a group of persons or even a company may have discovered an

opportunity.
● If such a person or a group of persons or a company proceeds to form a company then
they are said to be the promoters of the company.
● A promoter is said to be the one who undertakes risk to form a company with reference
to a given project and to set it gong and who takes the necessary steps to accomplish
that purpose.
● Thus, apart from concelving a business opportunity the promoters analyse its
prospects and bring together the men, materials, machinery, managerial abilities and
financial resources and set the organisation going.

As per section 69, a promoter means a person

● Who has been named as such in a prospectumor is identified by the company in the
annual return) referred to in section 92.
● Who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or otherwise.
● In accordance with whose advice, directions or instructions the Board of Directors of
the company is accustomed to act. However, it is provided that nothing in this sub-
clause shall apply to a person who is acting merely in a professional capacity.
Functions of a Promoter

1. Identification of business opportunity:

● The first and foremost activity of a promoter is to identify a business opportunity.

● The opportunity may be in respect of producing a new product or service or making
some product avallable through a different channel or any other opportunity having an
investment potential.
● Such opportunity is then analysed to see its technical and economic feasibility.

2. Feasibility studies:

● It may not be feasible or profitable to convert all identifled business opportunities into
real projects.
● The promoters, therefore, undertake detailed feasibility studies to investigate all
aspects of the business they intend to start.

(a) Technical feasibility:

● Sometimes an idea may be good but technically not possible to execute.

● It may be so because the required raw material or technology is not easily available.

(b) Financial feasibility:

● Every business activity requires funds.

● The promoters have to estimate the fund requirements for the identified business
opportunity.
● If the required outlay for the project is so large that it cannot easily be arranged within
the available means, the project has to be given up.

(c) Economic feasibility:

● Sometimes it so happens that a project is technically viable and financially feasible but
the chance of it being profitable is very little. In such cases as well, the idea may have
to be abondoned.
● Promoters usually take the help of experts to conduct these studies. It may be noted
that these experts do not become promoters just because they are assisting the
promoters in these studies.
● Only when these investigations throw up positive results, the promoters may decide to
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actually launch a company.

3. Name approval:

Having decided incorporate to a company, the promoters have to select a name for it and
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.

Name Clause

A name is considered undesirable in the following cases:

● If it is identical with or too closely resembles the name of an existing company

● 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.
● 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.

In such cases the proposed name is not accepted but some alternate name may be approved.
Therefore, three names. in order of their priority are given in the application to the Registrar
of Companies. (Proforma INC1 Is given at the end of the Book).

4. Fixing up Signatories to the Memorandum of Association:

● Promoters have to decide about the members who will be signing the Memorandum of
Association of the proposed company.
● Usually the people signing memorandum are also the first Directors of the Company.
● Their written consent to act as Directors and to take up the qualification shares in the
company is necessary.

5. Appointment of professionals:

● Certain professionals such as mercantile bankers, auditors etc., are appointed by the
promoters to assist them in the preparation of necessary documents which are
required to be with the Registrar of Companies.
● The names and addresses of shareholders and the number of shares allotted of each is
submitted to the Registrar in a statement called return of allotment.

6. Preparation of necessary documents:

● The promoter takes up steps to prepare certain legal documents, which have to be
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submitted under the law, to the Registrar of the Companies for getting the company
registered.
● These documents are Memorandum of Association, Articles of Association and
Consent of Directors.

Documents Required to be Submitted

1. Memorandum of Association:

● Memorandum of Association is the most important document as it defines the

objectives of the company.
● No company can legally undertake activities that are not contained in its Memorandum
of Association.
● As per section 2(56) of The Companies Act, 2013 "memorandum" means the
memorandum of association of a company as originally framed or as altered from time
to time in pursuance of any previous company law or of this Act.

The Memorandum of Association contains different clauses, which are given as follows:

(i) The name clause:

This clause contains the name of the company with which the company will be known, which
has already been approved by the Registrar of Companies.

(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 the same
must be notified to the Registrar within thirty days of the incorporation of the
company.

(iii) Objects clause:

● This is probably the most important clause of the memorandum. It defines the purpose
for which the company is formed.
● A company is not legally entitled to undertake an activity, which is beyond the objects
stated in this clause. The main objects for which the company is formed are listed in
this sub-clause.
 ● It must be observed that an act which is either essential or incidental for the
attainment of the main obiects of the company is deemed to be valid, although it may
not have been stated explicitly.

(iv) Liability clause:

● This clause limits the liability of the members to the amount unpaid on the shares
owned by them.
● For example, if a shareholder has purchased 1000 shares of $710 each and has already
paid $6 per share, his/her liability is limited to $4 per share. Thus, even in the worst
case, he/she may be called upon to pay $4,000 only.

(v) Capital clause:

● This clause 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.
● For example, the authorised share capital of the company may be 25 lakhs with divided
into 2.5 lakh shares of rupees 10 each. The said company cannot issue share capital in
excess of the amount mentioned in this clause.
● The signatories to the Memorandum of Association state their intention to be
associated with the company and give their undertaking to subscribe to the shares
mentioned against their names.
● The memorandum of a company shall be in respective forms specified in Tables A, B,
C, D and E in Schedule 1 as may be applicable to such company.
● The Memorandum of Association must be signed by at least seven persons in case of a
public company and by two persons in case of a private company.

2. Articles of Association:

● Articles of Association are 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
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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.

3. Consent of Proposed Directors:

Apart from the Memorandum and Articles of Association, a written consent of each person
named as a director is required confirming that they agree to act in that capacity and
undertake to buy and pay for qualification shares, as mentioned in the Articles of
Association.

4. Agreement:

The agreement, if any, which the company proposes to enter with any individual for
appointment as its Managing Director or a whole time Director or Manager is another
document which is required to be submitted to the registrar for getting the company
registered under the Act.

5. Statutory Declaration:

● A declaration stating that all the legal requirements pertaining to registration have
been complied with is to be submitted to the Registrar with the above mentioned
documents for getting the company registered under the law.
● This statement can be signed by an advocate or by a Chartered Accountant or a Cost
Accountant or a Company Secretary in practice who is engaged in the formation of a
company and by a person named in the articles as a director or manager or secretary
of the company.

6. Receipt of Payment of fee:

● Along with the above-mentioned documents, necessary fees has to be paid for the
registration of the company.
● The amount of such fees shall depend on the authorised share capital of the company.
Qualification Shares

● To ensure that the directors have some stake in the proposed company, the Articles
usually have a provision requiring them to buy a certain number of shares.
● They have to pay for these shares before the company obtains Certificate of
Commencement of Business.
● These are called Qualification Shares.
Incorporation

● After completing the aforesaid formalities, promoters make an application for the
incorporation of the company.
● The application is to be filed with the Registrar of Companies of the state within which
they plan to establish the registered office of the company.

The application for registration must be accompanied with the:

1. The Memorandum of Association duly stamped, signed and witnessed.

● In case of a public company, at least seven members must sign it. 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.

2. The Articles of Association duly stamped and witnessed as in case of the

Memorandum.

● However, as stated earlier, a public company may adopt Table A, which is a model set
of Articles, given in the Companies Act.
● In that case a statement in lieu of the prospectus is submitted, instead of Articles of
Association.

3. Written consent of the proposed directors to act as directors and an undertaking to

purchase qualification shares.

4. The agreement, if any, with the proposed Managing Director, Manager or whole-time
director.

5. A copy of the Registrar's letter approving the name of the company.

6. A statutory declaration affirming that all legal requirements for registration have
been complied with. This must be duly signed.

7. 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.
 8. Documentary evidence of payment of registration fees.

● The Registrar upon submission of the application along with the required documents
has to be satisfied that the documents are in order and that all the statutory
requirements regarding the registration have been complied with.
● However, it is not his duty to carry out a thorough investigation about the authenticity
of the facts mentioned in the documents.
● When the Registrar is satisfied, about the completion of formalities for registration, a
Certificate of Incorporation is issued to the company, which signify the birth of the
company.
● The certificate of incorporation may therefore be called the birth certificate of the
company.
● With effect from November 1, 2000, the Registrar of Companies allots a CIN (Corporate
Identity Number) to the Company.

Preliminary Contracts

● During the promotion of the company, promoters enter into certain contracts with third
parties on behalf of the company. These are called preliminary contracts or pre-
incorporation contracts.
● These are not legally binding on the company. A company after coming into existence
may, if it so chooses, decide to enter into fresh contracts with the same terms and
conditions to honour the contracts made by the promoters.
● Note that it cannot ratify a preliminary contract. A company thus cannot be forced to
honour a preliminary contract. Promoters, however, remain personally liable to third
parties for these contracts.

Director Identification Number (DIN)

● Every Individual intending to be appointed as director of a company shall make an

application for allotment of Director Identification Number (DIN) to the Central
Government in prescribed form along with fees.
● The Central Government shall allot a Director Identification Number to an application
within one month from the receipt of the application.
● No individual, who has already been allotted a Director Identification Number, shall
apply for, obtain or possess another Director Identification Number
Capital Subscription

● A public company can raise the required funds from the public by means of issue of
securities (shares and debentures etc.).
● For doing the same, it has to issue a prospectus which is an invitation to the public to
subscribe to the capital of the company and undergo various other formalities.

The following steps are required for raising funds from the public:

1. SEBI Approval

● SEBI (Securities and Exchange Board of India) which is the regulatory authority in our
country has issued guidelines for the disclosure of information and investor protection.
● A public company inviting funds from the general public must make adequate
disclosure of all relevant information and must not conceal any material information
from the potential investors. This is necessary for protecting the interest of the
investors.
● Prior approval from SEBI is, therefore, required before going ahead with raising funds
from public.

2. 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'.
● Investors make up their minds about investment in a company primarily on the basis of
the information contained in this document. Therefore, there must not be a mis-
statement in the prospectus and all material significant information must be fully
disclosed.

3. Appointment of Bankers, Brokers, Underwriters:

● Raising funds from the public is a stupendous task. The application money is to be
received by the bankers of the company.
● The brokers try to sell the shares by distributing the forms and encouraging the public
to apply for the shares.
● If the company is not reasonably assured of a good public response to the issue, it may
appoint underwriters to the issue.
● Underwriters undertake to buy the shares if these are not subscribed by the public.
They receive a commission for underwriting the issue. Appointment of underwriters is
not necessary.

4. Minimum Subscription

● In order to prevent companies from commencing business with inadequate resources,

it has been provided that the company must receive applications for a certain minimum
number of shares before going ahead with the allotment of shares.
● According to the Companies Act, this is called the 'minimum subscription'. As per the
SEBI Guidelines the limit of minimum subscription is 90 per cent of the size of the
issue.
● Thus, 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.

5. Application to Stock Exchange:

● An application is made to 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.

6. Allotment of Shares

● Till the time shares are alloted, application money received shoud remain in a seperate
bank account and must not be used by the company.
● 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.
● Allotment letters are issued to the successful allottees. 'Return of allotment', signed by
a director or secretary is filed with the Registrar of Companies within 30 days of
allotment.

● A public company may not invite public to subscribe to its securities. Instead, it can
raise the funds through friends, relatives or some private arrangements as done by a
private company. In such cases, there is no need to issue a prospectus.
 ● A 'Statement in Lieu of Prospectus' is filed with the Registrar at least three days
before making the allotment.

One Person Company

With the implementation of The Companies Act, 2013, a single person could constitute a
company, under the One Person Company (OPC) concept.
The introduction of OPC in the legal system is a move that would encourage corporatisation
of micro businesses and entrepreneurship.
In India, in the year 2005, the JJ Iran Expert Committee recommended the formation of OPC.
It had suggested that such an entity may be provided with a simpler legal regime through
exemptions so that the small entrepreneur is not compelled to devote considerable time,
energy and resources on complex legal compliance.
One Person Company is a company with only one person as a member. That one person will
be the shareholder of the company. It avails all the benefits of a private limited company such
as separate legal entity, protecting personal assets from business liability and perpetual
succession.

Characteristics

1. Only a natural person who is an Indian citizen and resident in India-

● Shall be eligible to incorporate a One Person Company;

● Shall be a nominee for the sole member of a One Person Company.

Explanation - For the purposes of this rule, the term "resident in India" means a person who
has stayed in India for a period of not less than one hundred and eighty two days during the
immediately preceding one calendar year.

2. No person shall be eligible to incorporate more than a One Person Company or become
nominee in more than one such company.

3. Where a natural person, being member in One Person Company in accordance with this
rule becomes a member in another such Company by virtue of his being a nominee in
that One Person Company, such person shall meet the eligibility criteria specified in
sub rule (2) within a period of one hundred and eighty days.

4. No minor shall become member or nominee of the One Person Company or can hold
share with beneficial interest.
5. Such Company cannot be incorporated or converted into a company under section 8 of
the Act.

6. Such Company cannot carry out Non-Banking Financial Investment activities including
investment in securities of anybody corporates.

7. No such company can convert voluntarily into any kind of company unless two years
have expired from the date of incorporation of One Person Company, except threshold
limit (paid up share capital) is increased beyond fifty lakh rupees or its average annual
turnover during the relevant period exceeds two crore rupees.