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Business Studies: Class 11 — Chapter 7: Formation of a Company

Introduction to Company Formation

Formation of a company is a highly structured and legally regulated process. It involves transitioning a business concept into a distinct legal entity. Unlike simpler business forms, a company requires compliance with the Companies Act, 2013, and involves multiple progressive stages.

Business Case Title: Avtar's Carburettor Venture

Corporate Context/Problem: Avtar, an automobile engineer, developed a highly efficient carburettor. To produce it on a large scale, he needs substantial capital and faces high risk, making sole proprietorship or partnership unsuitable.

Strategic Action Taken: He evaluates different business structures and is advised to form a corporate entity to pool resources and limit liability.

Managerial Inference: Complex business ideas with high capital requirements and risks are best structured as corporate entities, requiring systematic promotion and incorporation.

Stages in the Formation of a Company

  • Promotion: The conceptualization and initial organization of the business opportunity.
  • Incorporation: The formal registration of the company under the Companies Act.
  • Subscription of Capital: The process of raising funds from the public (applicable primarily to public limited companies).
Promotion of a Company

Promotion is the first stage in company formation. It begins with conceiving a business idea and taking the initiative to form a company to exploit a business opportunity.

Functions of a Promoter

  1. Identification of Business Opportunity: Recognizing a potential product, service, or investment avenue.
  2. Feasibility Studies: Conducting detailed investigations to analyze viability:
    • Technical Feasibility: Assessing if the technology, raw materials, or skills are available.
    • Financial Feasibility: Estimating the required capital outlay and whether it can be raised.
    • Economic Feasibility: Evaluating the commercial profitability of the project.
  3. Name Approval: Selecting and securing approval for the company's name from the Registrar of Companies (ROC).
  4. Fixing up Signatories to the MOA: Deciding who will sign the Memorandum of Association and act as the first directors.
  5. Appointment of Professionals: Engaging mercantile bankers, auditors, and legal advisors to assist with documentation.
  6. Preparation of Necessary Documents: Drafting legal documents required for registration.

Legal Position of Promoters

Promoters enjoy a fiduciary position relative to the company. They must not make any secret profits and are personally liable for all preliminary contracts entered into before incorporation unless ratified by the company after its birth.

Documents Required for Registration

To register a company, several critical legal documents must be prepared and submitted to the Registrar of Companies.

1. Memorandum of Association (MOA)

The Memorandum of Association is the principal document of the company, defining its constitution, powers, and boundaries. It contains five essential clauses:

  • Name Clause: The approved name of the company.
  • Registered Office Clause: The state in which the registered office is to be situated.
  • Objects Clause: The purpose and activities for which the company is established.
  • Liability Clause: Limits the liability of members to the unpaid amount on their shares.
  • Capital Clause: Specifies the maximum authorized share capital the company can raise.

2. Articles of Association (AOA)

The Articles of Association contain the rules, regulations, and bylaws for the internal management of the company. They are subsidiary to the MOA.

Comparison: MOA vs. AOA

Basis of DifferenceMemorandum of Association (MOA)Articles of Association (AOA)
ObjectivesDefines the objects for which the company is formed.Rules of internal management to achieve objectives.
PositionMain document, subordinate to the Companies Act.Subsidiary document, subordinate to both MOA and the Act.
RelationshipDefines relationship of the company with outsiders.Defines relationship between members and the company.
ValidityActs beyond MOA are ultra vires and cannot be ratified.Acts beyond AOA can be ratified by members if they do not violate MOA.
NecessityCompulsory for every company to file.Not compulsory for public limited companies (can adopt Table F).

Other Key Documents

  • Consent of Proposed Directors: Written consent of directors agreeing to act in that capacity and buy qualification shares.
  • Agreement: Agreements with proposed managing directors or managers.
  • Statutory Declaration: A declaration affirming that all legal requirements for registration have been met.
  • Payment of Fees: Proof of payment of the prescribed registration fee.
Incorporation and Commencement of Business

Once the documents are submitted and verified, the Registrar issues the Certificate of Incorporation.

Effect of the Certificate of Incorporation

The Certificate of Incorporation serves as the birth certificate of the company. It provides conclusive evidence that the company is legally born as a separate legal entity with perpetual succession, regardless of any procedural deficiencies prior to registration.

Director Identification Number (DIN)

Every individual intending to be appointed as a director must obtain a unique Director Identification Number (DIN) from the Central Government.

Capital Subscription Stage

A public company raising capital from the public must complete the capital subscription stage before commencing business operations.

Steps in Capital Subscription

  1. SEBI Approval: Obtaining clearance from the Securities and Exchange Board of India to ensure adequate investor protection and disclosure.
  2. Filing of Prospectus: Submitting a copy of the prospectus (or statement in lieu of prospectus) to the ROC.
  3. Appointment of Intermediaries: Appointing bankers, brokers, and underwriters to facilitate the share issue.
  4. Minimum Subscription: Ensuring that applications are received for at least 90% of the issued size (as per SEBI guidelines). If minimum subscription is not met, all application money must be refunded.
  5. Application to Stock Exchange: Applying to at least one stock exchange for permission to trade shares.
  6. Allotment of Shares: Issuing allotment letters to successful applicants and filing a 'Return of Allotment' with the ROC.

Preliminary vs. Provisional Contracts

  • Preliminary Contracts: Signed by promoters with third parties before incorporation; not legally binding on the company.
  • Provisional Contracts: Signed after incorporation but before obtaining the certificate of commencement of business; binding only after the company is authorized to commence business.