NCERT Class XI Business Studies: Chapter 7 – Formation of A Company

NCERT Class XI Business Studies: Chapter 7 – Formation of A Company

National Council of Educational Research and Training (NCERT) Book for Class XI
Subject: Business Studies
Chapter: Chapter 7 – Formation of A Company

Class XI NCERT Business Studies Text Book Chapter 7 Formation of A Company is given below.

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

  •  specify the important stages in the formation of a company;
  • describe the steps involved in each stage of company formation;
  • specify the documents to be submitted to the registrar ofcompanies; and
  • state the need of certificate of incorporation and certificate tocommence business.

Avtar, a brilliant automobile engineer, has recently developed a new carburettorin his factory which he is running as a sole proprietor. The new carburettor cancut down petrol consumption of a car engine by 40 percent. He is now thinkingof producing it on a large scale for which he requires a large amount of money.He is to evaluate different forms of organisations for doing the business ofmanufacturing and marketing his carburettor. He decides against convertinghis sole proprietorship to partnership as the requirement of funds for the projectis large and the product being new, there is a lot of risk involved. He is advisedto form a company. He wants to know about the formalities required for theformation of a company.

7.1 INTRODUCTION

Modern day business requires largeamount of money. Also, due toincreasing competition and fastchanging technological environment,the element of risk is increasing. As aresult, the company form oforganisation is being preferred by moreand more business firms, particularlyfor setting up medium and large sizedorganisations.

The steps which are required fromthe time a business idea originates tothe time, a company is legally ready tocommence business are referred to asstages in the formation of a company.Those who are taking these steps andthe associated risks are promoting acompany and are called its promoters.

The present chapter describes insome details the stages in the formationof a company and also the stepsrequired to be taken in each stage sothat a fair idea about these aspects canbe made.

7.2 FORMATION OF A COMPANY

As discussed in an earlier chapter on‘Forms of organisations’, formation ofa company is a complex activityinvolving completion of a lot of legalformalities and procedures. To fullyunderstand the process one candivide the formalities into four distinctstages, which are: (i) P r o m o t i o n ;(ii) Incorporation; (iii) Subscription ofcapital; and (iv) Commencement of business.

It may, however, be noted that thesestages are appropriate from the pointof view of formation of a public limitedcompany. As far as the private limitedcompanies are concerned only the firsttwo stages mentioned above areappropriate. In other words, a privatecompany can start its businessimmediately after obtaining thecertificate of incorporation. As it isprohibited to raise funds from public,it does not need to issue a prospectusand complete the formality of minimumsubscription. A public company, on theother hand, goes through the capitalsubscription stage and then receivesthe certificate of commencement. Thus,it has to undergo all the four stages.In the next section, we shall discussthese four stages in the formation of acompany in some detail.

7.2.1 Promotion of a CompanyPromotion is the first stage in theformation of a company. It involvesconceiving a business opportunity andtaking an initiative to form a companyso that practical shape can be given toexploiting the available businessopportunity. Thus, it begins withsomebody having discovered a potentialbusiness opportunity. Any person ora group of persons or even a companymay have discovered an opportunity.If such a person or a group of personsor a company proceeds to form acompany, then, they are said to be thepromoters of the company.

There is no statutory definition ofa promoter. A promoter is said to bethe one who undertakes to form acompany with reference to a givenproject and to set it going and whotakes the necessary steps to accomplishthat purpose. Thus, apart fromconceiving a business opportunity thepromoters analyse its prospects andbring together the men, materials,machinery, managerial abilities andfinancial resources and set theorganisation going.

After thoroughly examining thefeasibility of the idea, the promotersassemble resources, prepare necessarydocuments, give a name and performvarious other activities to get acompany registered and obtain thenecessary certificate enabling thecompany to commence business.Thus, the promoters perform variousfunctions to bring a company intoexistence.

Functions of a Promoter: The important functions of promotersmay be listed as below:

(i) Identification of businessopportunity: The first and foremostactivity of a promoter is to identify abusiness opportunity. The opportunitymay be in respect of producing a newproduct or service or making someproduct available through a differentchannel or any other opportunityhaving an investment potential. Suchopportunity is then analysed to see itstechnical and economic feasibility.

(ii) Feasibility studies: It may not befeasible or profitable to convert allidentified business opportunities intoreal projects. The promoters, therefore,undertake detailed feasibility studiesto investigate all aspects of the businessthey intend to start. Depending uponthe nature of the project, the followingfeasibility studies may be undertaken,with the help of the specialists likeengineers, chartered accountants etc.,to examine whether the perceivedbusiness opportunity can be profitablyexploited.

(a) Technical feasibility: Sometimesan idea may be good buttechnically not possible to execute.It may be so because the requiredraw material or technology is noteasily available. For example, in ourearlier story suppose Avtar needsa particular metal to produce thecarburettor. If that metal is notproduced in the country andbecause of poor political relations,it can not be imported from the country which produces it, theproject would be technicallyunfeasible until arrangements aremade to make the metal availablefrom alternative sources.

(b) Financial feasibility: Every business activity requires funds.The promoters have to estimate thefund requirements for the identifiedbusiness opportunity. If therequired outlay for the project is solarge that it cannot easily bearranged within the availablemeans, the project has to be givenup. For example, one may thinkthat developing townships is verylucrative. It may turn out that therequired funds are in several croresof rupees, which cannot bearranged by floating a company bythe promoters. The idea may beabandoned because of the lack offinancial feasibility of the project.

(c) Economic feasibility: Sometimesit so happens that a project istechnically viable and financiallyfeasible but the chance of it beingprofitable is very little. In such casesas well, the idea may have to beabondoned. Promoters usually takethe help of experts to conduct thesestudies. It may be noted that theseexperts do not become promotersjust because they are assisting thepromoters in these studies.Only when these investigationsthrow up positive results, thepromoters may decide to actuallylaunch a company.

(iii) Name approval: Having decidedto launch a company, the promotershave to select a name for it and submit,an application to the registrar ofcompanies of the state in which theregistered office of the company is tobe situated, for its approval. Theproposed name may be approved if itis not considered undesirable. It mayhappen that another company existswith the same name or a very similarname or the preferred name ismisleading, say, to suggest that the

Name Clause

A name is considered undesirable in the following cases:

(a) If it is identical with or too closely resembles the name of an existingcompany

(b) If it is misleading. It is so considered if the name suggests that the companyis in a particular business or it is an association of a particular type whenit is not true

(c) If it is violative of the provisions of ‘The Emblem and Names (Prevention ofImproper Use) Act 1950, as given in the schedule to this Act. This schedulespecifies, inter alia, the name, emblem or official seal of the UNO and itsbodies like WHO, UNESCO etc. Government of India, State Governments,President of India or Governer of any State, the Indian National Flag. TheAct also prohibits use of any name which may suggest patronage ofGovernment of India, or any state government or any local authority company is in a particular business whenit is not true. In such cases the proposedname is not accepted but some alternatename may be approved. Therefore, threenames, in order of their priority are givenin the application to the Registrar ofCompanies. (Performa Application foravailability of names (Form 1A) is givenat the end of the chapter.)

(iv) Fixing up Signatories to theMemorandum of Association:Promoters have to decide about themembers who will be signing theMemorandum of Association of theproposed company. Usually the peoplesigning memorandum are also the firstDirectors of the Company. Their writtenconsent to act as Directors and to takeup the qualification shares in thecompany is necessary.

(v) Appointment of professionals:Certain professionals such asmercantile bankers, auditors etc., areappointed by the promoters to assistthem in the preparation of necessarydocuments which are required to bewith the Registrar of Companies. Thenames and addresses of shareholdersand the number of shares allotted toeach is submitted to the Registrar in astatement called return of allotment.

(vi) Preparation of necessarydocuments: The promoter takes upsteps to prepare certain legaldocuments, which have to besubmitted under the law, to theRegistrar of the Companies for gettingthe company registered. Thesedocuments are Memorandum ofAssociation, Articles of Association andConsent of Directors.

Documents Required to beSubmitted

A. Memorandum of Association:Memorandum of Association is themost important document as itdefines the objectives of thecompany. No company can legallyundertake activities that are notcontained in its Memorandum ofAssociation. The Memorandum ofAssociation contains differentclauses, which are given as follows:

(i) The name clause: This clausecontains the name of the company withwhich the company will be known,which has already been approved bythe Registrar of Companies.

(ii) Registered office clause: Thisclause contains the name of the state,in which the registered office of thecompany is proposed to be situated.The exact address of the registeredoffice is not required at this stage butthe same must be notified to theRegistrar within thirty days of theincorporation of the company.

(iii) Objects clause: This is probablythe most important clause of thememorandum. It defines the purposefor which the company is formed. Acompany is not legally entitled toundertake an activity, which is beyondthe objects stated in this clause. Theobject clause is divided into two subclauses,which are:

  • The main objects: The mainobjects for which the company isformed are listed in this sub-clause.It must be observed that an actwhich is either essential or incidentalfor the attainment of the main objectsof the company is deemed to bevalid, although it may not have beenstated explicitly in the sub-clause.
  •  Other objects: Objects not included in the main objects could be statedin this sub-clause. However, if a  company wishes to undertake abusiness included in this subclause, it has to either pass a specialresolution or pass an ordinaryresolution and get central government’s approval for the same.

(iv) Liability clause: This clause limitsthe liability of the members to theamount unpaid on the shares ownedby them.For example, if a shareholder haspurchased 1000 shares of Rs.10 eachand has already paid Rs. 6 per share,his/her liability is limited to Rs. 4 pershare. Thus, even in the worst case,he/she may be called upon to payRs. 4, 000 only.

(v) Capital clause: This clausespecifies the maximum capital whichthe company will be authorised to raisethrough the issue of shares. Theauthorised share capital of theproposed company along with itsdivision into the number of shareshaving a fixed face value is specified inthis clause. For example, theauthorised share capital of thecompany may be Rs. 25 with dividedinto 2.5 lakh shares of Rs.10 each. Thesaid company cannot issue sharecapital in excess of the amountmentioned in this clause.

(vi) Association clause: In thisclause, the signatories to theMemorandum of Association state theirintention to be associated with thecompany and also give their consentto purchase qualification shares.

The Memorandum of Associationmust be signed by at least sevenpersons in case of a public companyand by two persons in case of a privatecompany.

A copy of a Memorandum ofAssociation is given at the end of thechapter.

B. Articles of Association: Articles ofAssociation are the rules regardinginternal management of a company.These rules are subsidiary to theMemorandum of Association andhence, should not contradict orexceed anything stated in theMemorandum of Association. Apublic limited company may adoptTable A which is a model set ofarticles given in the Companies Act.Table A is a document containingrules and regulations for the internalmanagement of a company. If acompany adopts Table A, there is noneed to prepare separate Articles of Association. For companies not

Association Clause

The association clause reads as under:“We, the several persons whose names and addresses are subscribed, are desirousof being formed into a company in pursuance of this Memorandum of Association,and we respectively agree to take the number of shares in the capital of thecompany set opposite our respective names.”

adopting Table A, a copy of theArticles of Association, stamped andduly signed by signatories to theMemorandum of Association isrequired for registration.

C. Consent of Proposed Directors:Apart from the Memorandum andArticles of Association, a writtenconsent of each person named as adirector is required confirming thatthey agree to act in that capacityand undertake to buy and pay forqualification shares, as mentionedin the Articles of Association.

D. Agreement: The agreement, if any,which the company proposes toenter with any individual forappointment as its ManagingDirector or a whole time Director orManager is another documentwhich is required to be submittedto the Registrar for getting thecompany registered under the Act.

E. Statutory Declaration: Adeclaration stating that all the legalrequirements pertaining toregistration have been compliedwith is to be submitted to theRegistrar with the above mentioneddocuments for getting the companyregistered under the law. Thisstatement can be signed by anadvocate of High Court or SupremeCourt or by a Chartered Accountantin full time practice or by a personnamed in the articles as a directoror manager or secretary of thecompany. Performa of statutorydeclaration given.

F. Payment of fee: Along with theabove-mentioned documents,necessary fees has to be paid for theregistration of the company. Theamount of such fees shall depend onthe authorised share capital ofthe company.

Position of Promoters

Promoters undertake various activitiesto get a company registered and get itto the position of commencement ofbusiness. But they are neither theagents nor the trustees of the company.They can’t be the agents as thecompany is yet to be incorporated.Therefore, they are personally liable forall the contracts which are entered bythem, for the company before itsincorporation, in case the same are notratified by the company later on. Alsopromoters are not the trustees ofthe company.

Promoters of a company enjoy afiduciary position with the company,which they must not misuse. They canmake a profit only if it is disclosed butmust not make any secret profits. Inthe event of a non-disclosure, thecompany can rescind the contract andrecover the purchase price paid to thepromoters. It can also claim damages

Qualification Shares

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

NCERT Class XI Business Studies: Chapter 7 – Formation of A Company

for the loss suffered due to thenon-disclosure of material information.Promoters are not legally entitled toclaim the expenses incurred in thepromotion of the company. However,the company may choose to reimbursethem for the pre-incorporationexpenses. The company may alsoremunerate the promoters for theirefforts by paying a lump sum amountor a commission on the purchase priceof property purchased through themor on the shares sold. The companymay also allot them shares ordebentures or give them an option topurchase the securities at a future date.

7.2.2 Incorporation

After completing the aforesaidformalities, promoters make an application for the incorporation ofthe company. The application is to befiled with the Registrar of Companiesof the state within which they plan toestablish the registered office of thecompany. The application forregistration must be accompaniedwith certain documents about whichwe have already discussed in theprevious sections. These may bebriefly mentioned again:

1. The Memorandum of Associationduly stamped, signed andwitnessed. In case of a publiccompany, at least seven membersmust sign it. For a privatestatement in lieu of the prospectusis submitted, instead of Articlesof Association.

2. Written consent of the proposeddirectors to act as directors andan undertaking to purchasequalification shares.

3. The agreement, if any, with theproposed Managing Director,Manager or whole-time director.

4. A copy of the Registrar’s letterapproving the name of thecompany.

5. A statutory declaration affirmingthat all legal requirements forregistration have been complied

Preliminary Contracts

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

company however the signaturesof two members are sufficient.The signatories must also giveinformation about their address,occupation and the number ofshares subscribed by them.

6. The Articles of Association dulystamped and witnessed as in caseof the Memorandum. However, asstated earlier, a public companymay adopt Table A, which is amodel set of Articles, given in theCompanies Act. In that case awith. This must be signed by anadvocate of a High court orSupreme Court or a signatory tothe Memorandum of Associationor a Chartered Accountant orCompany Secretary in whole timepractice in India.

7. A notice about the exact addressof the registered office may also besubmitted along with thesedocuments. However, if the sameis not submitted at the time ofincorporation, it can be submitted within 30 days of the receipt of thecertificate of incorporation.

8. Documentary evidence of paymentof registration fees.

The Registrar upon submission ofthe application along with the requireddocuments has to be satisfied that thedocuments are in order and that all thestatutory requirements regarding theregistration have been complied with.However, it is not his duty to carry outa thorough investigation about theauthenticity of the facts mentioned inthe documents.

When the Registrar is satisfied,about the completion of formalitiesfor registration, a Certificate ofIncorporation is issued to the company,which signify the birth of the company.The certificate of incorporation maytherefore be called the birth certificateof the company.

With effect from November 1, 2000,the Registrar of Companies allots aCIN (Corporate Identity Number) tothe Company.

Effect of the Certificate ofIncorporation

A company is legally born on the dateprinted on the Certificate of
NCERT Class XI Business Studies: Chapter 7 – Formation of A Company

Incorporation. It becomes a legal entitywith perpetual succession on suchdate. It becomes entitled to enter intovalid contracts. The Certificate ofIncorporation is a conclusive evidenceof the regularity of the incorporation ofa company. Imagine, what wouldhappen to an unsuspecting party withwhich the company enters into acontract, if it is later found that theincorporation of the company wasimproper and hence invalid. Therefore,the legal situation is that once aCertificate of Incorporation has beenissued, the company has become alegal business entity irrespective of anyflaw in its registration. The Certificateof Incorporation is thus conclusiveevidence of the legal existence of thecompany. Some interesting examplesshowing the impact of the

conclusiveness of the Certificate ofIncorporation are as under:

(a) Documents for registration werefiled on 6th January. Certificate ofIncorporation was issued on 8thJanuary. But the date mentionedon the Certificate was 6th January.It was decided that the companywas in existence and the contractssigned on 6th January wereconsidered valid.

(b) A person forged the signaturesof others on the Memorandum.The Incorporation was stillconsidered valid.

Thus, whatever be the deficiency inthe formalities, the Certificate ofIncorporation once issued, is aconclusive evidence of the existence ofthe company. Even when a companygets registered with illegal objects, thebirth of the company cannot bequestioned. The only remedy availableis to wind it up. Because the Certificateof Incorporation is so crucial, theRegistrar has to go very carefully beforeissuing it. On the issue of Certificate ofIncorporation, a private company canimmediately commence its business. Itcan raise necessary funds fromfriends, relatives or through privatearrangement and proceed to startbusiness. A public company, however,has to undergo two more stages inits formation.

7.2.3 Capital Subscription

A public company can raise therequired funds from the public bymeans of issue of shares anddebentures. For doing the same, it hasto issue a prospectus which is aninvitation to the public to subscribe tothe capital of the company and undergovarious other formalities. The followingsteps are required for raising fundsfrom the public:

(i) SEBI Approval: SEBI (Securitiesand Exchange Board of India) which isthe regulatory authority in our countryhas issued guidelines for the disclosureof information and investor protection.A company inviting funds from thegeneral public must make adequatedisclosure of all relevant informationand must not conceal any materialinformation from the potentialinvestors. This is necessary forprotecting the interest of the investors.

NCERT Class XI Business Studies: Chapter 7 – Formation of A Company

Prior approval from SEBI is, therefore,required before going ahead withraising funds from public.

(ii) Filing of Prospectus: A copy ofthe prospectus or statement in lieu ofprospectus is filed with the Registrarof Companies. A prospectus is ‘anydocument described or issued as aprospectus including any notice,circular, advertisement or otherdocument inviting deposits from thepublic or inviting offers from the publicfor the subscription or purchase of anyshares or debentures of, a bodycorporate’. In other words, it is aninvitation to the public to apply forshares or debentures of the companyor to make deposits in the company.

Provisional Contract

These are contracts which are signed after incorporation but before thecommencement of business. These become enforceable only after the companygets the Certificate of Commencement of Business.

Investors make up their minds aboutinvestment in a company primarily onthe basis of the information containedin this document. Therefore, theremust not be a mis-statement inthe prospectus and all significantinformation must be fully disclosed.

(iii) Appointment of Bankers,Brokers, Underwriters: Raising fundsfrom the public is a stupendous task.The application money is to be receivedby the bankers of the company. Thebrokers try to sell the sharesby distributing the forms andencouraging the public to apply for theshares. If the company is notreasonably assured of a good publicresponse to the issue, it may appointunderwriters to the issue. Underwritersundertake to buy the shares if theseare not subscribed by the public. Theyreceive a commission for underwritingthe issue. Appointment of underwritersis not necessary.

(iv) Minimum Subscription: Inorder to prevent companies fromcommencing business with inadequateresources, it has been provided that thecompany must receive applications fora certain minimum number of sharesbefore going ahead with the allotmentof shares. According to the CompaniesAct, this is called the ‘minimumsubscription’. The limit of minimumsubscription is 90 per cent of the sizeof the issue. Thus, if applicationsreceived for the shares are for anamount less than 90 per cent of theissue size, the allotment cannot bemade and the application moneyreceived must be returned to theapplicants.

(v) Application to Stock Exchange:An application is made to at least onestock exchange for permission to dealin its shares or debentures. If suchpermission is not granted before theexpiry of ten weeks from the date ofclosure of subscription list, theallotment shall become void and allmoney received from the applicants willhave to be returned to them withineight days.

(vi) Allotment of Shares: In case thenumber of shares allotted is less thanthe number applied for, or where noshares are allotted to the applicant, theexcess application money, if any, is tobe returned to applicants or adjustedtowards allotment money due fromthem. Allotment letters are issued tothe successful allottees. Return ofallotment, signed by a director orsecretary is filed with the Registrar ofCompanies within 30 days of allotment.A public company may not invitepublic to subscribe to its shares ordebentures. Instead, it can raise thefunds through friends, relatives or
some private arrangements as done by a private company. In such cases, thereis no need to issue a prospectus. A‘Statement in Lieu of Prospectus’ is filedwith the Registrar at least three daysbefore making the allotment.

7.2.4 Commencement of Business

If the amount of minimum subscriptionis raised through new issue of shares, apublic company applies to the Registrarof Companies for the issue of Certificateof Commencement of Business. Thefollowing documents are required:

1. A declaration that shares payablein cash have been subscribed forand allotted up to the minimumsubscription mentioned in theprospectus;

2. A declaration that every directorhas paid in cash, the applicationand allotment money on his shares
in the same proportion as others;

3. A declaration that no money ispayable or liable to becomepayable to the applicants becauseof the failure of the company toeither apply for or obtainpermission to deal in its securitieson a stock exchange; and

4. A statutory declaration that theabove requirements have beencomplied with. This declaration canbe signed by a director or secretaryof the company.

A public company raising fundsprivately, which has earlier filed aStatement in lieu of prospectus, has tosubmit only documents 2 and 4 listedabove.

The Registrar shall examinethese documents. If these arefound satisfactory, a ‘Certificate ofCommencement of Business’ will beissued. This certificate is conclusiveevidence that the company is entitledto do business. With the grant of thiscertificate the formation of a publiccompany is complete and the companycan legally start doing business.

NCERT Class XI Business Studies: Chapter 7 – Formation of A Company

Memorandum of Association(Specimen)

1. Name: The name of the company is Excellent Educational Services Limited.It is hereinafter referred to as EES Ltd.

2. Registered Office: The Registered office of the company shall be situated inthe NCT of Delhi and at present it is at: Sri Aurobindo Marg, New Delhi-16.

3. (A) Main Objectives:

(a) To engage in the design, development and delivery of world class serviceproducts in the sphere of education for domestic as well as global markets.

(b) To establish and strengthen presence/market share in the various segmentsrepresenting various stages in the education/re-education process in thelife-long learning context, viz., identification of prospects, curriculum-design,pedagogy, examination and evaluation, anticipating societal/market needs,content-delivery, placement services and human resource development andrenewal.

(c) To develop, publish/produce teaching, training and study materials,journals, periodicals, reports, books, monographs and other multilingualliterature/multimedia products for promoting the objectives of the company.

(d) To organise programmes, conferences, lectures, seminars, symposia andworkshops on issues impacting education, industry, business and society.

(B) Ancillary Objectives:

(a) To develop special competencies and capabilities for designing, developing anddelivering service products for persons with physical and mental disabilities;

(b) To liaison and network with various individuals and institutions ingovernment and non-government sectors and fostering mutually beneficialrelationship in the field of education;

(c) To host a website for virtual learning;

(d) To build up a research and reference library and to undertake documentationservices;

(e) To own, purchase, lease, movable and immovable property in furtherance ofthe aims and objectives of the company;

(f) To offer prizes, grants, stipends and scholarships in furtherance of theobjectives of company;

(g) To provide a forum for raising, discussing and resolving of issues, problemsand challenges in the field of education; and

(h) To do generally all such other lawful things as are conducive or incidental tothe attainment of the above objectives.

4. Liability Clause: Liability of the members would be limited to the amount ofunpaid value of the share.

5. Capital Subscription Clause: The company shall be registered with a capitalof Rs. 2.5 crore divided into Rs. 25 lakh shares of Rs.10 each.

We the following persons voluntarily agreed to be the signatories to theMemorandum of Association:

NCERT Class XI Business Studies: Chapter 7 – Formation of A Company
NCERT Class XI Business Studies: Chapter 7 – Formation of A Company

Key Terms

  • Promotion
  • Articles of Association
  • Prospectus
  • Incorporation
  • Capital subscription
  • Memorandum of Association Preliminary contracts
  • Statutory declaration
  • Certificate of Commencement

SUMMARY

There are two stages in the formation of a private company, promotion andincorporation. A public company has to undergo capital subscription stageand then get certificate of commencement of business, to begin operations.

1. Promotion: It begins with a potential business idea. Certain feasibilitystudies e.g. technical, financial and economic, are conducted todetermine whether the idea can be profitably exploited. In case, theinvestigations yield favourable results, promoters may decide to formthe company. Persons who conceive the business idea, decide to form acompany, take necessary steps for the same, and assume associatedrisks, are called promoters.

Steps in Promotion

i. Approval of company’s name is taken from the Registrar ofCompanies

ii. Signatories to the Memorandum of Association are fixed

iii. Certain professionals are appropriated to assist the promoters

iv. Documents necessary for registration are prepared

Necessary Documents

a. Memorandum of Association

b. Articles of Association

c. Consent of proposed directors

d. Agreement, if any, with proposed managing or whole time director

e. Statutory declaration

2. Incorporation: An application is made by promoters to the Registrar ofCompanies alongwith necessary documents and registration fees. TheRegistrar, after due scrutiny, issues certificate of incorporation. Theregistration may be refused only in case of a major defect in thedocuments. The certificate of incorporation is a conclusive evidence ofthe legal existence of the company. Even if there has been a major

defect in the incorporation, legal existence of the company can not berejected.

3. Capital Subscription: A public company raising funds from the publicneeds to take following steps for fund raising:

(i) SEBI approval;

(ii) File a copy of prospectus with the Registrar of Companies;

(iii) Appointment of brokers, bankers and underwriters etc.;

(iv) Ensure that minimum subscription is received;

(v) Application for listing of company’s securities;

(vi) Refund/adjust excess application money received;

(vii) Issue allotment letters to successful applicants; and

(viii) File return of allotment with the Registrar of Companies (ROC).

A public company, raising funds, raising funds from friends/relatives (notpublic) has to file a statement in lieu of prospectus with the ROC at leastthree days before allotment of shares and returns of allotment aftercompleting the allotment.

4. Commencement of Business: A public company raising funds frompublic has to apply to the Registrar of Companies for the certificate ofcommencement of business alongwith the following documents.

(i) A declaration about meeting minimum subscription requirement;

(ii) A declaration about details in respect of allotment to directors;

(iii) A declaration about no money being payable to applicants; and

(iv) A statutory declaration.

A public company raising funds privately has to submit only documents

(ii) and (iv) listed above.

The Registrar, upon satisfaction, issues Certificate of Commencement ofBusiness. This certificate is also a conclusive evidence of completion offormation requirements.

Preliminary Contracts: Contracts signed by promoters with third partiesbefore the incorporation of company.

Provisional Contracts: Contracts signed after incorporation but beforecommencement of business.

EXERCISES

Multiple Choice Questions

1. Minimum number of members to form a private company is

(a) 2 (b) 3

(c) 5 (d) 7

2. Minimum number of members to form a public company is

(a) 5 (b) 7

(c) 12 (d) 21

3. Application for approval of name of a company is to be made to

(a) SEBI (b) Registrar of Companies

(c) Government of India (d) Government of the Statein which Company is tobe registered

4. A proposed name of Company is considered undesirable if

(a) It is identical with the name (b) It resembles closely withof an existing company the name of an existingcompany

(c) It is an emblem of Government (d) In case of any of the aboveof India, United Nations etc.

5. A prospectus is issued by

(a) A private company (b) A public company seekinginvestment frompublic

(c) A public enterprise (d) A public company

6. Stages in the formation of a public company are in the following order

(a) Promotion, Commencement (b) Incorporation, Capitalof Business, Incorporation, Subscription,Capital Subscription Commencement ofBusiness, Promotion

(c) Promotion, Incorporation, (d) Capital Subscription,Capital Subscription, Promotion, Incorporation,Commencement of Business Commencement of Business

7. Preliminary Contracts are signed

(a) Before the incorporation (b) After incorporation butbefore capital subscription

(c) After incorporation but before (d) After commencement ofcommencement of business business

8. Preliminary Contracts are

(a) binding on the Company (b) binding on the Company, ifratified after incorporation

(c) binding on the (d) not binding on theCompany, after incorporation Company

True/False Answer Questions

1. It is necessary to get every company incorporated, whether private orpublic.

2. Statement in lieu of prospectus can be filed by a public company goingfor a public issue.

3. A private company can commence business after incorporation.

4. Experts who help promoters in the promotion of a company are alsocalled promoters.

5. A company can ratify preliminary contracts after incorporation.

6. If a company is registered on the basis of fictitious names, itsincorporation is invalid.

7. ‘Articles of Association’ is the main document of a company.

8. Every company must file Articles of Association.

9. A provisional contract is signed by promoters before the incorporationof the company.

10. If a company suffers heavy issues and its assets are not enough to payoff its liabilities, the balance can be recovered from the private assets ofits members.

Short Answer Questions

1. Name the stages in the formation of a company.

2. List the documents required for the incorporation of a company.

3. What is a prospectus? Is it necessary for every company to file aprospectus?

4. Explain the term, ‘Minimum Subscription’.

5. Briefly explain the term ‘Return of Allotment’.

6. At which stage in the formation of a company does it interact with SEBI.

7. Distinguish between ‘preliminary contracts’ and ‘provisional contracts’.

Long Answer Questions

1. What is meant by the term ‘Promotion’. Discuss the legal position ofpromoters with respect to a company promoted by them.

2. Explain the steps taken by promoters in the promotion of a company.

3. What is a ‘Memorandum of Association’? Briefly explain its clauses.

4. Distinguish between ‘Memorandum of Association’ and ‘Articles ofAssociation.’

5. What is the effect of conclusiveness of the ‘Certificates of Incorporation’and ‘Commencement of Business’?

6. Is it necessary for a public company to get its share listed on a stockexchange? What happens if a public company going for a public issuefails to apply to a stock exchange for permission to deal in its securitiesor fails to get such permission?

Projects/Assignment

Find out from the office of the Registrar of Companies, the actual procedurefor formation of companies. Does it match with what you have studied.What are the obstacles which companies face in getting themselvesregistered.

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