Formation of a Company

Introduction

The formation of a company is a more complex process compared to setting up a sole proprietorship or a partnership. Since a company is an artificial person created by law, its creation involves fulfilling several legal requirements and procedures as laid down in the Companies Act, 2013.

The process of company formation can be broadly divided into three main stages:

Promotion: This involves conceiving a business idea, conducting feasibility studies, and taking preliminary steps to form a company.
Incorporation (Registration): This is the legal process of getting the company registered with the Registrar of Companies (ROC), giving it a separate legal identity.
Capital Subscription: This stage involves raising necessary capital by inviting the public to subscribe to the company's shares and debentures. This stage is primarily relevant for public companies that intend to raise funds from the public.
Commencement of Business: After successfully raising capital, a public company needs to obtain a Certificate of Commencement of Business before it can start its operations (though this requirement has been simplified/removed for most companies under the latest amendments). A private company can commence business immediately after incorporation.

Let's explore these stages in detail.

Formation Of A Company

The process begins with the identification of a business opportunity and taking steps to bring the company into existence.

Promotion Of A Company

Promotion is the first stage in the formation of a company. It starts with the conception of a business idea and ends with the registration of the company. It involves all the preliminary steps necessary for the formation of a company.

The individuals who undertake the process of promotion are called Promoters.

Functions Of A Promoter

Promoters perform several key functions:

1. Identification of Business Opportunity

This is the initial step where the promoter identifies a potentially profitable business idea. This could be manufacturing a new product, providing a new service, or exploiting an existing opportunity.

2. Feasibility Studies

Once an opportunity is identified, the promoter undertakes detailed studies to check the viability of the idea. This involves various feasibility studies.

3. Name Approval

The promoter has to decide the name of the company and check its availability with the Registrar of Companies (ROC). The proposed name must not be identical or too similar to an existing company's name and must not be undesirable or prohibited under the Emblems and Names (Prevention of Improper Use) Act, 1950. Application is made to the ROC for approval and reservation of the name.

4. Fixing Up Signatories To The Memorandum Of Association (MOA)

The promoter identifies the individuals who will act as the first shareholders and sign the Memorandum of Association. For a public company, there must be at least seven signatories, and for a private company, at least two. These signatories also agree to take a certain number of shares.

5. Appointment Of Professionals

Promoters appoint necessary professionals such as mercantile bankers, auditors, lawyers, and consultants who will assist in the drafting of key documents and completing legal formalities.

6. Preparation Of Necessary Documents

Promoters get the essential legal documents of the company prepared. The most important documents are the Memorandum of Association (MOA) and the Articles of Association (AOA).

Feasibility Studies

Feasibility studies are conducted by the promoter to assess whether the business idea is practicable and profitable. Different types of studies include:

Technical Feasibility: Examining if the required technology, machinery, and technical expertise are available for the proposed business.
Financial Feasibility: Assessing the capital required for the project and the sources of finance. It determines whether the project is financially viable and has the potential to be profitable.
Economic Feasibility: Evaluating the demand for the product/service, market size, competition, and potential profitability in the overall economic scenario.

A project is pursued only if all these studies indicate a positive outlook.

Name Approval

Choosing and getting a name approved is a crucial step. The promoter applies to the ROC for the availability of the chosen name(s). The name must follow guidelines laid down in the Companies Act, 2013 (Section 4) and associated rules. Once a name is approved, it is reserved for the applicant for a limited period (usually 20 days for a new company application).

Fixing Up Signatories To The Memorandum Of Association

The individuals who are willing to form the company and subscribe to its initial shares become the signatories to the MOA. Their names, addresses, occupations, and the number of shares they agree to take are mentioned in the MOA.

Appointment Of Professionals

Specialists are appointed to guide the promoter through the legal and financial intricacies of company formation. Auditors verify the accounts, bankers handle application money, lawyers draft legal documents, and consultants offer expert advice on various aspects.

Preparation Of Necessary Documents

The primary documents prepared are:

Memorandum of Association (MOA): It is the fundamental document and the charter of the company. It defines the objects, powers, and scope of the company's activities and its relationship with the outside world. No company can legally undertake any activity that is beyond the scope defined in its MOA. It contains several clauses like Name clause, Registered office clause, Objects clause, Liability clause, Capital clause, and Association clause.
Articles of Association (AOA): It is the document that contains the rules and regulations for the internal management of the company. It defines the duties, rights, and powers of the directors and officers and the mode and form in which the business of the company is to be carried on. It governs the relationship between the company and its members and among the members themselves.

Other documents like declarations, consent letters, etc., are also prepared.

Documents Required To Be Submitted

For incorporation, the promoter submits the following documents to the Registrar of Companies electronically:

The Memorandum of Association (MOA)
The Articles of Association (AOA)
A declaration by a professional (like CA, CS, Cost Accountant, or Advocate) involved in the formation, stating that all the requirements of the Companies Act and rules have been complied with.
A declaration from each of the subscribers to the MOA and the first directors, stating that they are not convicted of any offence, have not been found guilty of any fraud, etc., and that all documents filed are correct and complete.
Address for correspondence till the registered office is established.
Proof of identity and address of the subscribers and directors.
Consent of the proposed directors to act as directors.
Details of name approval.
Any other document as required by the Act or rules.

These documents are filed along with the prescribed fees.

Position Of Promoters

Promoters are not agents or trustees of the company because the company does not exist yet. However, they stand in a fiduciary relationship with the company they are forming and its future shareholders. This means they must act in good faith, not make secret profits from the promotion process, and disclose any interest they have in transactions entered into on behalf of the proposed company.

Incorporation (Registration)

This is the second stage, where the legal entity of the company comes into existence. Once the ROC is satisfied that all the required documents have been filed and legal formalities are complied with, the company's name is entered into the Register of Companies.

The ROC then issues a Certificate of Incorporation. This certificate is the birth certificate of the company.

Effect Of The Certificate Of Incorporation

The Certificate of Incorporation has several significant effects:

Creation of Legal Entity: The company comes into existence as a distinct legal entity separate from its members.
Perpetual Succession: The company acquires perpetual succession.
Common Seal: The company gets the right to have a common seal (though its use is now optional under certain conditions).
Conclusive Evidence: The Certificate of Incorporation is conclusive evidence that all the requirements for registration have been complied with and that the company is duly registered under the Companies Act, 2013. Even if there was an error in the procedure, the validity of the company's registration cannot be questioned after the issue of this certificate (Doctrine of Conclusiveness of Certificate of Incorporation).

Director Identification Number (DIN)

Every individual intending to be appointed as a director of a company must obtain a Director Identification Number (DIN) from the Central Government. This is a unique identification number. Proposed first directors of a company need to have a DIN before incorporation is completed.

Preliminary Contracts (or Pre-incorporation Contracts)

These are contracts entered into by the promoters on behalf of the company *before* its incorporation. Since the company does not exist at that time, it cannot be a party to such contracts.

The company is not bound by preliminary contracts.
The promoters are personally liable for preliminary contracts unless the contract explicitly states otherwise or the third party agrees to look only to the company.
The company can choose to adopt (ratify) preliminary contracts after its incorporation, provided the contracts are for the purposes of the company and are within its objects. If adopted, the company becomes liable, and the promoter's personal liability ceases (by novation, i.e., a new contract between the company and the third party).

These contracts are a significant risk area for promoters.

Capital Subscription

This stage is applicable primarily to a public company that wishes to raise funds from the general public by issuing shares or debentures. A private company cannot invite the public to subscribe to its shares and can start business immediately after obtaining the Certificate of Incorporation.

A public company must follow the following steps to raise capital from the public:

Sebi Approval

A public company intending to make a public issue of shares or debentures must file a draft prospectus with the Securities and Exchange Board of India (SEBI) for approval. SEBI is the regulatory authority for the capital markets in India. SEBI reviews the prospectus to ensure that all necessary disclosures are made to protect investor interests.

Filing Of Prospectus

After receiving SEBI's observations or approval, the company files the prospectus (or a red herring prospectus) with the Registrar of Companies (ROC). A prospectus is a document inviting the public to subscribe for the shares or debentures of the company. It contains detailed information about the company, its promoters, directors, objectives of the issue, terms of the issue, risks, financial information, etc.

Appointment Of Bankers, Brokers, Underwriters

Bankers: Appointed to receive application money from the public (usually through ASBA - Application Supported by Blocked Amount facility).
Brokers: Appointed to encourage the public to buy shares/debentures and help in distributing the issue.
Underwriters: Companies may appoint underwriters who guarantee to subscribe to the shares/debentures not subscribed by the public up to a certain limit. This helps ensure that the company receives the minimum subscription.

Minimum Subscription

As per the Companies Act, 2013, no allotment of shares can be made unless the amount of minimum subscription is received by the company. Minimum subscription is the minimum amount of capital required to meet the preliminary expenses and the cost of getting the business started. SEBI guidelines usually stipulate the minimum subscription as 90% of the issue size. If the minimum subscription is not received within a specified number of days from the issue of the prospectus (usually 30 days), the entire application money must be refunded to the applicants.

Application To Stock Exchange

Every public company making a public offer is required to apply to one or more recognised stock exchanges for permission to list its shares or debentures. The prospectus must state the name of the stock exchange(s) where listing application has been made. If permission for listing is not granted by at least one of the specified stock exchanges within a stipulated time, the allotment becomes void, and application money must be refunded.

Allotment Of Shares

If the minimum subscription is received and permission for listing is granted by the stock exchange(s), the company can proceed with the allotment of shares. Allotment is the process of accepting applications and distributing shares among the applicants. Allotment must be done in accordance with the terms of the prospectus and the provisions of the Companies Act and SEBI guidelines.

Difference Between Memorandum Of Association And Articles Of Association

Basis	Memorandum of Association (MOA)	Articles of Association (AOA)
Nature	It is the fundamental document; the charter of the company.	It contains rules for internal management.
Scope	Defines the objects and powers of the company and its relationship with the outside world.	Defines the rules for carrying out the objects stated in the MOA and governs the relationship among members and with the company.
Subordination	Supreme document; everything else is subordinate to it.	Subordinate to the MOA and the Companies Act.
Compulsory Status	Compulsory for every company.	Compulsory for certain companies (like Unlimited Co., Co. Ltd. by Guarantee, One Person Company). Public Co. Ltd. by Shares may adopt Table F instead.
Relationship	Defines the relationship between the company and outsiders.	Defines the relationship between the company and its members, and among members.
Alteration	Difficult to alter; requires special resolution and Central Government/NCLT approval in some cases.	Relatively easier to alter; usually requires a special resolution.

One Person Company (OPC)

The Companies Act, 2013 introduced the concept of a One Person Company (OPC) to provide a legal framework for individual entrepreneurs who wish to enjoy the benefits of a company structure, particularly limited liability and separate legal entity status, without the complexities of involving multiple members.

Characteristics

1. One Member

An OPC can have only one natural person as a member.

2. Nominee

The sole member must appoint a nominee (another natural person) in the Memorandum of Association. The nominee becomes the member of the OPC in the event of the death or incapacity of the original member. Written consent of the nominee is required.

3. Separate Legal Entity

Like other companies, an OPC is a separate legal entity distinct from its member. It can own property, enter contracts, and sue/be sued in its own name.

4. Limited Liability

The liability of the sole member is limited to the unpaid amount on the shares held by him, protecting his personal assets.

5. Perpetual Succession

Despite having only one member, the OPC has perpetual succession due to the nomination clause. The death or incapacity of the member does not lead to the closure of the company; the nominee steps in.

6. Minimum One Director

An OPC must have at least one director. The sole member can also be the sole director.

7. Conversion

An OPC has certain thresholds regarding its paid-up share capital and average annual turnover. If these limits are exceeded for two consecutive financial years, the OPC must be mandatorily converted into a Private or Public Company.

8. Compliance Requirements

While simplified compared to private/public companies, OPCs still have to comply with provisions of the Companies Act regarding maintenance of books of accounts, audits, and filing of annual returns.

OPC is a useful structure for small entrepreneurs who want the benefits of limited liability and formal recognition without needing multiple partners or members.