Forms of Business Organisation Part 2

Formation of a company
 Formation of the Company

Since a company is an artificial person, it has to be formed according to

legal provisions. In India, these legal provisions have been provided in the
Companies Act, 2013. Formation of a company involves following stages:
1. Promotion Stage
2. Incorporation stage
3. Capital subscription stage.
4. Commencement of business stage
 Promotion Stage

The term promotion refers to the sum total of activities by which a

business enterprise is brought into existence. At this stage the promotors
conceive the idea of promoting a company and the type of activities that it
intends to undertake. A promotor may be an individual like Jamsethji Tata,
group of individual or one or more companies.
 Functions of Promoters

(i) 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 available through a different channel or any other opportunity
having an investment potential. Such opportunity is then analysed to see
its technical and economic feasibility.
 Functions of Promoters

(ii) Feasibility studies: It may not be feasible or profitable to convert all

identified business opportunities into real projects. The promoters,
therefore, undertake detailed feasibility studies to investigate all aspects of
the business they intend to start. Depending upon the nature of the project,
the following feasibility studies may be undertaken, with the help of the
specialists like engineers, chartered accountants etc., to examine whether
the perceived business opportunity can be profitably exploited.
 Functions of Promoters

(ii) Feasibility studies:

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 they 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.
 Functions of Promoters

(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
abandoned. 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.
 Functions of Promoters

(iii) 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. It may happen that another
company exists with the same name or a very similar name or the
preferred name is misleading, say, to suggest that the company is in a
particular business when it is not true. 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
 Functions of Promoters

(iv) 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.
 Functions of Promoters

(v) 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 to each is submitted to the Registrar in a
statement called return of allotment
 Functions of Promoters

(vi) Preparation of necessary documents: The promoter takes up steps

to prepare certain legal documents, which have to be 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
MOA is a document which defines objects and powers of a
company and its scope of operations beyond which it cannot
operate.
The MOA contains different clauses which are as follows:

1. Name Clause: Name clause consists of the company. Promotors of

the company are free to choose any one name which they like,
subject to the following conditions:
a) Proposed name should not be identical or similar to an existing
company.
b) Proposed name should not convey any connection or link with a
Government department or local authority as it is undesirable and
may mislead the public.
c) Name of the company limited by shares should end with the word
‘Limited’ and that of a private limited company should end up with
words ‘Private Limited’.
The MOA contains different clauses which are as follows:

(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
The MOA contains different clauses which are as follows:

(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 objects of the company is deemed to be valid, although it may
not have been stated explicitly.
The MOA contains different clauses which are as follows:

(iv) Liability clause: Liability clause specifies the liability of members

of the company which is as follows:
a) In case of a company limited by shares, the liability of the members
is limited to the extent of issue price of the shares held by them.
Thus if the shares are not fully paid, liability of the members is
limited to the extent of the unpaid amount even in the case if
insolvency of the company.
b) In case the company limited by guarantee, the liability of the
members is limited to the extent of amount of guarantee given by
them.
The MOA contains different clauses which are as follows:

(v) Capital clause: Capital clause states the total share capital is
known as authorised share capital. This share capital is known as
authorised share capital. Its significance is that the company cannot
issue more share capital than the authorised share capital.
While mentioning the share capital, number of shares and face value of
each share are specified. If there are different categories of shares, this
information is provided for each category of shares.
The MOA contains different clauses which are as follows:

(vi) Subscription clause: Subscription or Association clause contains

names, address and signatories to the MOA as well as the number of
shares subscribed by each of them. In the case of public limited
company there must be at least seven signatories and in the case of a
private limited company, there must be at least two signatories.
 2. Articles of Association

Articles of Association contains rules and

regulations concerning internal management of
a company
Filling of AOA is governed by the provisions of
the Companies Act which are as follows:

1. A Public company limited by shares may, register

its own AOA or it may adopt Table A.
2. A Company limited by guarantee without having
share capital may file its own AOA or may adopt
Table D.
3. A company limited by guarantee and having
share capital may adopt Table D.
 Contents of AOA

A. Matters relating to the B. Matters relating to the Directors:

shareholders: 1. Rules regarding appointment,
1. Types, number and reappointment, remuneration,
denomination of shares removal etc. of Directors.
2. Voting power of shareholders. 2. Rules regarding borrowing
3. Procedure of forfeiture, partners of Directors.
reissue and surrender of 3. Rights and liabilities of
shares. Directors
4. Procedure regarding company 4. Rules regarding conducting
meetings meeting of directors.
5. Procedure of making calls and 5. Rules for fixing max. and min.
allotment of shares. number of directors.
 Contents of AOA

C. Other Matters:
1. Rules regarding keeping books of
accounts.
2. Borrowing funds from public and the rate
of interest.
3. Commission and brokerage of selling
shares to underwriters.
4. Rules regarding use and custody of
common seal.
5. Procedure of winding up of the company.
6. Interest rate of call in advance and call in
arrears.
C. Consent of Proposed D. Agreement: The agreement,
Directors: Apart from the if any, which the company
Memorandum and Articles of proposes to enter with any
Association, a written individual for appointment as its
consent of each person Managing Director or a whole
named as a director is time Director or Manager is
required confirming that they another document which is
agree to act in that capacity required to be submitted to the
and undertake to buy and pay Registrar for getting the
for qualification shares, as company registered under the
mentioned in the Articles of Act.
Association.
E. Statutory Declaration: A declaration
stating that all the legal requirements
pertaining to registration have been F. Receipt of Payment of fee:
complied with is to be submitted to the Along with the above-
Registrar with the above mentioned mentioned documents,
documents for getting the company necessary fees has to be paid for
registered under the law. This statement the registration of the company.
can be signed by an advocate or by a The amount of such fees shall
Chartered Accountant or a Cost depend on the authorised share
Accountant or a Company Secretary in capital of the company.
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.
 Incorporation Stage

This stage involves putting an application for registering the company

before the concerned registering the company before the concerned
Registrar of Companies and getting it registered. Incorporation stage
involves the following activities:
1. Filing registration application with the Registrar of companies along
with the relevant documents.

2. Scrutiny of the application and documents by the Registrar of

Companies.
 Incorporation Stage

3. Registering the company by the Registrar if all requirements are

fulfilled and entering the name of the company in the relevant
register.

4. Issue of Certificate of Incorporation by the Registrar of

Companies.
On issue of the Certificate of Incorporation, the company comes
into existence as an artificial person.
 Capital Subscription Stage

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.
 Capital Subscription Stage

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

(i) 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.
 Capital Subscription Stage

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

(ii) Filing of Prospectus: 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.
 Capital Subscription Stage

The following steps are required for raising funds

from the public:

(iii) 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
 Capital Subscription Stage

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

(iv) 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.
 Capital Subscription Stage

The following steps are required for raising funds from the public:
(v) 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.
 Capital Subscription Stage

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

(vi) Allotment of Shares: Till the time shares are allotted,

application money received should remain in a separate 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.
 Commencement of Business Stage

For commencing the business, a public company has to obtain the Certificate
of Commencement of business from the concerned Registrar of companies.
For this purpose, the company is required to submit the following
documents.
1. A declaration that the shares to be subscribed on cash basis have been
allotted.
2. A declaration that all the Directors have paid in cash for the shares
subscribed by them.
3. A declaration signed either by the director or the secretary of the company
that the above requirements have been complied with.
The Registrar of the company scrutinises the above documents and issues the
Certificate of Commencement of Business if all requirements are as per the
provisions of the Companies Act.
 Choice of form of Business Organisation

1. Nature of Business: Form of business organisation

should match with nature of business. Thus, for trading of
goods in small scale, sole proprietorship is the most
suitable. Similarly, where personalised service is required
for customers, this form is the most suitable. For
manufacturing business involving high technology,
company is more suitable.
 Choice of form of Business Organisation

2. Initial Capital Required: If initial capital requirement

is low, sole proprietorship or partnership is required.
However if the same business is to be run on large scale,
company is more suitable.
3. Scale of Operation: If the business has to be run on
small scale, sole proprietorship or partnership is suitable.
However, if the same business is to be run on large scale,
company is more suitable, for e.g. business of large scale
trading.
 Choice of form of Business Organisation

4. Cost and ease in setting up the organisation: As far as

initial business setting-up costs are concerned, sole
proprietorship is the most inexpensive way of starting a
business. In case of partnership also, the advantage of less
legal formalities and lower cost is there because of limited
scale of operations. Cooperative societies and companies
have to be compulsorily registered. Formation of a
company involves a lengthy and expensive legal
procedure. From the point of view of initial cost, therefore,
sole proprietorship is the preferred form as it involves least
expenditure.
 Choice of form of Business Organisation

5. Liability: In case of sole proprietorship and partnership

firms, the liability of the owners/partners is unlimited. This
may call for paying the debt from personal assets of the
owners. In joint Hindu family business, only the karta has
unlimited liability. In cooperative societies and companies,
however, liability is limited and creditors can force
payment of their claims only to the extent of the
company’s assets. Hence, from the point of view of
investors, the company form of organisation is more
suitable as the risk involved is limited.
 Choice of form of Business Organisation

6. Continuity: The continuity of sole proprietorship and

partnership firms is affected by such events as death,
insolvency or insanity of the owners. However, such
factors do not affect the continuity of business in the case
of organisations like joint Hindu family business,
cooperative societies and companies. In case the business
needs a permanent structure, company form is more
suitable. For short term ventures, proprietorship or
partnership may be preferred.
 Choice of form of Business Organisation

7. Degree of control: If direct control over operations and

absolute decision making power is required, proprietorship
may be preferred. But if the owners do not mind sharing
control and decision making, partnership or company form
of organisation can be adopted. The added advantage in the
case of company form of organisation is that there is
complete separation of ownership and management and it
is professionals who are appointed to independently
manage the affairs of a company.
 Choice of form of Business Organisation

8. Secrecy of Information: Secrecy of information is the

highest in sole proprietorship and the lowest in company.
The entrepreneur has to decide between these two
extremes and in between.
Bharatiya Vidya Bhavan’s
V.M. Public School
Baroda

Tasneem Hotelwala
PGT Commerce