Chapter 7: Formation of a Company
Introduction
Modern businesses require large amounts of capital due to growing competition, large-scale operations, and
rapidly changing technology. Because of these factors, the company form of organisation is preferred over sole
proprietorship or partnership for setting up medium and large businesses.
A company comes into existence only after completing certain legal formalities.
The process from conceiving a business idea to the stage when the company is legally ready to commence
operations is called the formation of a company.
Persons who take initiative, bear the risk, and perform the legal steps are called promoters.
📌 Example:
Avtar, an automobile engineer, invents a carburettor that reduces petrol consumption by 40%. He cannot produce it
at a large scale as a sole proprietor due to huge financial needs and risk. Hence, he is advised to form a company.
Stages in the Formation of a Company
The process is divided into three stages:
1. Promotion
2. Incorporation
3. Capital Subscription (only for public companies)
1. Promotion of a Company
Meaning: Promotion is the first stage, involving discovery of a business opportunity and taking steps to give it a
practical shape by forming a company.
Who is a Promoter?
A person or group who undertakes to form a company.
As per Section 69 of Companies Act:
o Named in the prospectus or identified in annual return, or
o Exercises control over company’s affairs, or
o Gives advice/directions to the Board.
⚠️ Professionals like lawyers or CAs assisting in technical work are not promoters.
Functions of Promoters:
1. Identifying a business opportunity
o Could be a new product/service or new method of distribution.
o Example: Avtar identified an opportunity in fuel-saving carburettors.
2. Conducting feasibility studies (with experts’ help):
o Technical Feasibility: Is technology/raw material available?
Ex: If Avtar’s carburettor requires a rare metal unavailable in India, project may fail.
o Financial Feasibility: Can funds be raised?
Ex: Developing a township may need crores of rupees – if funds are not possible, project is
dropped.
o Economic Feasibility: Is the project profitable?
Ex: A business may be possible technically but if profits are too low, idea may be abandoned.
3. Name Approval
o Promoters propose 3 names in order of preference to the Registrar.
o A name will be rejected if:
It is identical/similar to an existing company,
Misleading, or
Violates the Emblems and Names (Prevention of Improper Use) Act, 1950 (e.g., using
“UNO” or “Government of India”).
4. Fixing Signatories to Memorandum of Association (MOA)
o MOA signatories are usually first directors.
o They must give written consent and agree to buy qualification shares.
5. Appointment of Professionals
o Promoters appoint bankers, auditors, lawyers, etc. to prepare legal documents.
6. Preparation of Necessary Documents
o Memorandum of Association (MOA) – defines objectives of company.
o Articles of Association (AOA) – rules of internal management.
o Consent of Directors – written consent to act and buy qualification shares.
o Agreements – with MD, manager, etc. if any.
o Statutory Declaration – confirming compliance with rules.
2. Incorporation
Once documents are ready, promoters apply to the Registrar of Companies with:
1. MOA (signed by minimum 7 members for public, 2 for private company).
2. AOA (or adopt Table F).
3. Consent of Directors.
4. Agreement with MD/Manager (if any).
5. Registrar’s name approval letter.
6. Statutory declaration of compliance.
7. Address of registered office (within 30 days).
8. Evidence of fee payment.
Certificate of Incorporation:
Issued by Registrar once satisfied.
This is the birth certificate of the company.
From this date, the company becomes a legal entity with perpetual succession.
📌 Examples of Legal Effect:
If Certificate says 6th Jan, but issued on 8th Jan, company legally exists from 6th Jan.
Even if signatures on MOA were forged, company’s incorporation cannot be challenged.
3. Capital Subscription (Only for Public Companies)
Private companies can start business after incorporation, but public companies need funds from the public. Steps:
1. SEBI Approval – company must disclose all material facts to protect investors.
2. Filing Prospectus – an invitation to public to subscribe to shares/debentures.
3. Appointment of Bankers, Brokers, Underwriters –
o Bankers: collect application money.
o Brokers: encourage people to apply.
o Underwriters: guarantee subscription (paid commission).
4. Minimum Subscription – At least 90% of issued capital must be subscribed. Otherwise, money is refunded.
5. Application to Stock Exchange – for permission to list shares.
6. Allotment of Shares – only after minimum subscription is achieved.
o Excess application money refunded/adjusted.
o Return of Allotment filed with Registrar within 30 days.
Key Legal Documents
1. Memorandum of Association (MOA) – external document, defines objectives.
o Name clause, Registered office clause, Objects clause, Liability clause, Capital clause.
o Example: If authorised capital is ₹25 lakh, company cannot issue more than that.
2. Articles of Association (AOA) – internal rules of management.
o Covers share issue, meetings, directors, dividends, accounts, etc.
3. Prospectus – invitation to public to invest.
4. Consent of Directors & Qualification Shares – ensures directors have stake.
Legal Position of Promoters
Promoters are not agents (company doesn’t exist yet).
Not trustees but have fiduciary relation with company.
Liable for secret profits or non-disclosure.
Expenses may be reimbursed, remuneration can be given via cash, shares, commission, etc.
Preliminary contracts (before incorporation) are not binding on company. Promoters remain personally
liable unless new contracts are signed later.
One Person Company (OPC)
Introduced under Companies Act, 2013.
A single person can form a company.
Benefits: separate legal entity, limited liability, perpetual succession.
Restrictions:
o Only Indian resident can form OPC.
o Cannot be NBFC or Section 8 company.
o Cannot voluntarily convert into another company within 2 years unless capital > ₹50 lakh or turnover
> ₹2 crore.
Conclusion
Formation of a company is a legal process involving three stages – Promotion, Incorporation, and Capital
Subscription.
Private companies → Only Promotion + Incorporation needed.
Public companies → Must undergo Capital Subscription too.
This ensures companies are legally recognised, financially sound, and transparent to protect investors and
society.