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Formation of a Company

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Learning Objectives

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Learning Objectives

  • 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 of companies.
  • State the need for a certificate of incorporation and certificate to commence business.

Revision Notes & Summary

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Chapter 7: Formation of a Company

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 of companies.
  • State the need for a certificate of incorporation and certificate to commence business.

Stages in the Formation of a Company

  1. Promotion: This is the first stage where a business idea is conceived and steps are taken to form a company.
    • Steps in Promotion:
      • Approval of the company's name from the Registrar of Companies.
      • Fixing signatories to the Memorandum of Association.
      • Appointment of professionals to assist in document preparation.
      • Preparation of necessary documents:
        • Memorandum of Association
        • Articles of Association
        • Consent of proposed directors
        • Agreement with proposed managing or whole-time director
        • Statutory declaration
  2. Incorporation: An application is made to the Registrar of Companies along with necessary documents and registration fee. The Registrar issues a certificate of incorporation after scrutiny.
    • Certificate of Incorporation: This is conclusive evidence of the legal existence of the company.
  3. Capital Subscription: A public company raising funds from the public must follow these steps:
    • SEBI approval.
    • File a copy of the prospectus with the Registrar of Companies.
    • Appointment of brokers, bankers, and underwriters.
    • Ensure minimum subscription is received (90% of shares to be issued).
    • Application for listing of company's securities.
    • Refund/adjust excess application money received.
    • Issue allotment letters to successful applicants.
    • File return of allotment with the Registrar of Companies (ROC).

Important Documents Required for Incorporation

  • Memorandum of Association: Defines the objectives for which the company is formed.
  • Articles of Association: Rules of internal management of the company.
  • Consent of Proposed Directors: Written consent confirming their agreement to act as directors.
  • Agreement with Proposed Managing Director: If applicable.
  • Statutory Declaration: Affirmation that all legal requirements for registration have been complied with.

Key Terms

  • Promotion: The process of initiating the formation of a company.
  • Prospectus: An invitation to the public to apply for securities of the company.
  • Memorandum of Association: The main document defining the company's objectives.
  • Incorporation: The legal process of forming a company.
  • Articles of Association: Internal rules governing the company.
  • Capital Subscription: The process of raising funds from the public.
  • Commencement of Business: The stage when a company can start its operations.

Exam Tips & Common Mistakes

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Common Mistakes and Exam Tips

Common Pitfalls

  • Misunderstanding the Stages of Company Formation: Students often confuse the stages of promotion, incorporation, and capital subscription. Ensure you can clearly define and differentiate each stage.
  • Confusing Memorandum of Association with Articles of Association: Memorandum defines the company's objectives and relationship with outsiders, while Articles govern internal management. Be clear on their differences.
  • Neglecting the Importance of the Certificate of Incorporation: Some students overlook the significance of this document, which is crucial as it serves as conclusive evidence of the company's legal existence.
  • Ignoring Minimum Subscription Requirements: Failing to understand that a public company must receive applications for at least 90% of the shares before allotment can lead to confusion.

Exam Tips

  • Review Key Documents: Familiarize yourself with the Memorandum of Association and Articles of Association, including their clauses and purposes.
  • Understand the Role of SEBI: Know the importance of SEBI approval in the capital subscription stage and what it entails for companies raising funds.
  • Practice Differentiating Terms: Be prepared to explain terms like 'preliminary contracts' and 'provisional contracts' and their relevance in company formation.
  • Use Diagrams: If applicable, use flowcharts or diagrams to illustrate the stages of company formation during your exam to enhance clarity.
  • Time Management: Allocate time wisely during the exam to ensure you can address all questions thoroughly.
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Practice Test – MCQs, True/False

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Multiple Choice Questions

A.

Articles of Association

B.

Memorandum of Association

C.

Prospectus

D.

Certificate of Incorporation
Correct Answer: B

Solution:

The Memorandum of Association defines the objectives for which the company is formed and is the most important document as it outlines the scope of activities the company can undertake.

A.

Articles of Association

B.

Prospectus

C.

Memorandum of Association

D.

Certificate of Incorporation
Correct Answer: C

Solution:

The Memorandum of Association defines the objectives of the company.

A.

They provide financial support.

B.

They conceive the business idea and take steps to form the company.

C.

They manage the company's daily operations.

D.

They are responsible for marketing the company's products.
Correct Answer: B

Solution:

Promoters conceive the business idea and take the necessary steps to form the company.

A.

Amend the Memorandum of Association

B.

Void the Certificate of Incorporation

C.

Wind up the company

D.

Reissue the Certificate of Incorporation
Correct Answer: C

Solution:

If a company is incorporated with illegal objects, the Certificate of Incorporation remains valid, and the only legal remedy is to wind up the company.

A.

To define the internal management rules of the company

B.

To outline the objectives for which the company is formed

C.

To list the names of the directors

D.

To specify the financial structure of the company
Correct Answer: B

Solution:

The Memorandum of Association defines the objectives for which the company is formed. It is the main document and acts as a charter of the company.

A.

Memorandum of Association

B.

Articles of Association

C.

Certificate of Incorporation

D.

Consent of Proposed Directors
Correct Answer: C

Solution:

The Certificate of Incorporation is not submitted for incorporation; it is issued after successful registration.

A.

It allows the company to start its business operations

B.

It is a conclusive evidence of the legal existence of the company

C.

It outlines the company's internal management rules

D.

It lists the company's financial obligations
Correct Answer: B

Solution:

The Certificate of Incorporation is a conclusive evidence of the legal existence of the company.

A.

It allows the company to raise capital from the public.

B.

It serves as conclusive evidence of the company's legal existence.

C.

It outlines the company's internal management rules.

D.

It specifies the company's authorized share capital.
Correct Answer: B

Solution:

The Certificate of Incorporation is conclusive evidence of the legal existence of the company, making it a legal entity with perpetual succession.

A.

Name Clause

B.

Registered Office Clause

C.

Liability Clause

D.

Capital Clause
Correct Answer: D

Solution:

The Capital Clause in the Memorandum of Association specifies the maximum amount of share capital that a company is authorized to raise.

A.

Name Clause

B.

Registered Office Clause

C.

Object Clause

D.

Liability Clause
Correct Answer: B

Solution:

The Registered Office Clause specifies the state in which the registered office of the company is proposed to be situated.

A.

To define the company's objectives

B.

To outline the internal management rules

C.

To specify the company's financial statements

D.

To list the company's directors
Correct Answer: B

Solution:

The Articles of Association are primarily concerned with the internal management of the company, detailing the rules and regulations for its operation.

A.

Name Clause

B.

Registered Office Clause

C.

Liability Clause

D.

Capital Clause
Correct Answer: B

Solution:

The Registered Office Clause in the Memorandum of Association specifies the state in which the company's registered office will be located.

A.

To list the directors of the company

B.

To declare the company's objectives

C.

To provide details of shares allotted to shareholders

D.

To outline the company's internal management rules
Correct Answer: C

Solution:

The 'Return of Allotment' document provides details of the shares allotted to shareholders.

A.

It is not necessary for a private company.

B.

It is a conclusive evidence of the company's legal existence.

C.

It outlines the internal management rules of the company.

D.

It is issued after the company commences business.
Correct Answer: B

Solution:

The Certificate of Incorporation is conclusive evidence of the legal existence of the company, confirming that it is a legal entity.

A.

Articles of Association

B.

Memorandum of Association

C.

Prospectus

D.

Certificate of Incorporation
Correct Answer: B

Solution:

The Memorandum of Association defines the objectives for which the company is formed.

A.

To define the objectives of the company

B.

To outline the internal management rules of the company

C.

To provide evidence of the company's legal existence

D.

To specify the company's authorized share capital
Correct Answer: B

Solution:

The Articles of Association are the rules regarding the internal management of a company.

A.

Promotion

B.

Incorporation

C.

Capital Subscription

D.

Commencement of Business
Correct Answer: C

Solution:

A private company does not undergo the capital subscription stage, which is required for public companies to raise funds from the public.

A.

Name clause

B.

Registered office clause

C.

Liability clause

D.

Capital clause
Correct Answer: C

Solution:

The liability clause in the Memorandum of Association specifies the liability of the members, which is typically limited to the amount unpaid on their shares.

A.

Articles of Association

B.

Prospectus

C.

Certificate of Incorporation

D.

Director Identification Number
Correct Answer: C

Solution:

The Certificate of Incorporation must be filed with the Registrar of Companies to legally establish a company's existence. It is conclusive evidence of the company's legal status.

A.

Approval of company's name from the Registrar of Companies

B.

Conducting feasibility studies

C.

Issuing shares to the public

D.

Fixing signatories to the Memorandum of Association
Correct Answer: C

Solution:

Issuing shares to the public is part of the capital subscription stage, not the promotion stage. During promotion, the focus is on feasibility studies, name approval, and preparing necessary documents.

A.

Conducting feasibility studies

B.

Filing a return of allotment with the Registrar

C.

Approving the company's name with the Registrar

D.

Fixing signatories to the Memorandum of Association
Correct Answer: B

Solution:

Filing a return of allotment with the Registrar is part of the capital subscription stage, not the promotion stage.

A.

Incorporation

B.

Promotion

C.

Capital Subscription

D.

Commencement of Business
Correct Answer: B

Solution:

The first stage in the formation of a company is Promotion, which involves conceiving a business idea and taking steps to form a company.

A.

Defines the company's objectives

B.

Provides rules for internal management

C.

Acts as a conclusive evidence of incorporation

D.

Specifies the state of the registered office
Correct Answer: B

Solution:

The Articles of Association are the rules regarding internal management of a company.

A.

Obtain a Certificate of Incorporation

B.

File a prospectus with the Registrar of Companies

C.

Prepare Articles of Association

D.

Appoint a Managing Director
Correct Answer: B

Solution:

A public company must file a prospectus with the Registrar of Companies before issuing shares to the public.

A.

It defines the company's objectives

B.

It is a conclusive evidence of the company's legal existence

C.

It outlines the internal management rules

D.

It specifies the company's share capital
Correct Answer: B

Solution:

The Certificate of Incorporation is a conclusive evidence of the legal existence of the company.

A.

Approval from SEBI

B.

Consent of proposed directors

C.

Issuance of a Certificate of Commencement of Business

D.

Signing of preliminary contracts
Correct Answer: A

Solution:

During the capital subscription stage, a public company must obtain approval from SEBI as part of the process to raise funds from the public.

A.

Articles of Association

B.

Prospectus

C.

Memorandum of Association

D.

Certificate of Incorporation
Correct Answer: C

Solution:

The Memorandum of Association is the main document of a company.

A.

Memorandum of Association

B.

Articles of Association

C.

Director Identification Number

D.

Statutory Declaration
Correct Answer: C

Solution:

While the Memorandum of Association, Articles of Association, and Statutory Declaration are necessary for incorporation, the Director Identification Number (DIN) is not a document submitted for incorporation but rather a number obtained by individuals intending to become directors.

A.

It allows the company to issue shares to the public.

B.

It serves as evidence of the company's legal existence.

C.

It authorizes the company to commence business operations.

D.

It provides the company with a tax identification number.
Correct Answer: B

Solution:

The Certificate of Incorporation is conclusive evidence of the legal existence of the company, allowing it to enter into valid contracts.

A.

50%

B.

75%

C.

90%

D.

100%
Correct Answer: C

Solution:

As per SEBI guidelines, a minimum subscription of 90% of the shares to be issued to the public is required for a public company to proceed with the allotment of shares.

A.

Articles of Association

B.

Certificate of Incorporation

C.

Prospectus

D.

Return of Allotment
Correct Answer: B

Solution:

The Certificate of Incorporation is conclusive evidence of the legal existence of the company.

A.

To define the internal management rules of the company

B.

To outline the objectives and scope of the company

C.

To list the names and addresses of the company's first directors

D.

To specify the company's financial statements
Correct Answer: B

Solution:

The Memorandum of Association defines the objectives and scope of the company, acting as a charter for its operations.

A.

Approval of company's name

B.

Issuance of Certificate of Incorporation

C.

Filing a copy of the prospectus with the Registrar of Companies

D.

Signing of Memorandum of Association
Correct Answer: C

Solution:

Filing a copy of the prospectus with the Registrar of Companies is a step in the capital subscription stage for a public company.

A.

Articles of Association

B.

Memorandum of Association

C.

Certificate of Incorporation

D.

Prospectus
Correct Answer: B

Solution:

The Memorandum of Association defines the objectives for which the company is formed and is considered the main document of the company.

A.

Memorandum of Association

B.

Articles of Association

C.

Certificate of Incorporation

D.

Prospectus
Correct Answer: C

Solution:

The Certificate of Incorporation is a conclusive evidence of the legal existence of the company. Once it is issued, the company is legally recognized.

A.

To define the internal management rules of the company

B.

To outline the objectives for which the company is formed

C.

To list the names of the directors

D.

To specify the financial statements of the company
Correct Answer: B

Solution:

The Memorandum of Association defines the objectives for which the company is formed.

A.

Defines the relationship of the company with outsiders

B.

Contains rules for internal management

C.

Subordinate to the Memorandum of Association

D.

Can be altered by the company
Correct Answer: A

Solution:

The Articles of Association do not define the relationship of the company with outsiders; that is the role of the Memorandum of Association. The Articles are concerned with internal management.

A.

The company can proceed with the business operations.

B.

The company must refund the application money received.

C.

The company can issue additional shares to meet the shortfall.

D.

The company must reduce the number of shares issued.
Correct Answer: B

Solution:

As per SEBI guidelines, if a public company does not receive at least 90% of the issued shares as minimum subscription, it must refund the application money received.

A.

Memorandum of Association

B.

Articles of Association

C.

Certificate of Incorporation

D.

Prospectus
Correct Answer: A

Solution:

The Memorandum of Association is the most important document as it defines the objectives of the company.

A.

Promotion

B.

Incorporation

C.

Capital Subscription

D.

Marketing Strategy
Correct Answer: D

Solution:

Marketing Strategy is not a stage in the formation of a company.

A.

Promotion

B.

Incorporation

C.

Capital Subscription

D.

Commencement of Business
Correct Answer: A

Solution:

The Promotion stage begins with a potential business idea and involves conducting feasibility studies to determine whether the idea can be profitably exploited.

A.

Memorandum of Association

B.

Articles of Association

C.

Certificate of Incorporation

D.

Prospectus
Correct Answer: A

Solution:

The Memorandum of Association is the most important document as it defines the objectives of the company. No company can legally undertake activities that are not contained in its Memorandum of Association.

A.

Issuing shares to the public

B.

Filing a return of allotment

C.

Conducting feasibility studies

D.

Applying for a Director Identification Number
Correct Answer: C

Solution:

During the promotion stage, promoters conduct feasibility studies to assess the technical, financial, and economic viability of the business idea.

A.

Issuance of shares

B.

Filing of Articles of Association

C.

Certificate of Incorporation

D.

Certificate to Commence Business
Correct Answer: D

Solution:

A public company must obtain a Certificate to Commence Business before it can start operations.

A.

Incorporation

B.

Promotion

C.

Capital Subscription

D.

Commencement of Business
Correct Answer: B

Solution:

Promotion involves conducting feasibility studies to determine if a business idea can be profitably exploited.

A.

Promotion

B.

Incorporation

C.

Capital Subscription

D.

Commencement of Business
Correct Answer: B

Solution:

Incorporation involves the submission of necessary documents to the Registrar of Companies.

A.

Approval from the Board of Directors

B.

Minimum subscription is received

C.

Consent from all shareholders

D.

Completion of annual audit
Correct Answer: B

Solution:

A public company must ensure that the minimum subscription is received before issuing allotment letters to successful applicants.

A.

They must sign the Articles of Association

B.

They must purchase qualification shares

C.

They must file a prospectus

D.

They must approve the company's name
Correct Answer: B

Solution:

Directors must purchase qualification shares before the company can obtain a Certificate of Commencement of Business.

A.

Promotion

B.

Incorporation

C.

Capital Subscription

D.

Commencement of Business
Correct Answer: C

Solution:

In the capital subscription stage, a public company must prepare and file a prospectus with the Registrar of Companies.

A.

Promotion

B.

Incorporation

C.

Dissolution

D.

Capital Subscription
Correct Answer: C

Solution:

The stages in the formation of a company include Promotion, Incorporation, and Capital Subscription. Dissolution is not a stage in the formation but rather the winding up of a company.

A.

Promotion

B.

Incorporation

C.

Capital Subscription

D.

Commencement of Business
Correct Answer: C

Solution:

During the Capital Subscription stage, a public company raising funds from the public needs to interact with SEBI for approval.

True or False

Correct Answer: False

Solution:

No company can legally undertake activities that are not contained in its Memorandum of Association.

Correct Answer: False

Solution:

A private company is prohibited from raising funds from the public and does not need to issue a prospectus.

Correct Answer: True

Solution:

During the capital subscription stage, a public company is required to file a copy of the prospectus with the Registrar of Companies.

Correct Answer: True

Solution:

The Memorandum of Association is the main document of a company and defines its objectives.

Correct Answer: True

Solution:

Promoters take steps to prepare necessary legal documents, including the Memorandum of Association and Articles of Association, for company registration.

Correct Answer: True

Solution:

A company is legally born on the date printed on the Certificate of Incorporation, which is conclusive evidence of its legal existence.

Correct Answer: True

Solution:

Once issued, the Certificate of Incorporation is conclusive evidence of the legal existence of the company, regardless of any flaws in the registration process.

Correct Answer: True

Solution:

The Articles of Association are rules of internal management and are subordinate to both the Memorandum of Association and the Companies Act.

Correct Answer: True

Solution:

One of the steps in the promotion stage is for promoters to obtain approval of the company's name from the Registrar of Companies.

Correct Answer: False

Solution:

A private company is prohibited from raising funds from the public and therefore does not need to issue a prospectus.

Correct Answer: False

Solution:

A private company is not required to file a prospectus as it is prohibited from raising funds from the public.

Correct Answer: False

Solution:

The Memorandum of Association defines the relationship of the company with outsiders, not its members.

Correct Answer: False

Solution:

Preliminary contracts are signed by promoters with third parties before the incorporation of the company.

Correct Answer: True

Solution:

The Memorandum of Association outlines the objectives of the company and is a crucial document in its formation.

Correct Answer: True

Solution:

The Certificate of Incorporation marks the legal existence of a company, making it a legal entity with perpetual succession from the date mentioned.

Correct Answer: False

Solution:

A private company does not need to issue a prospectus as it is prohibited from raising funds from the public.

Correct Answer: False

Solution:

The Articles of Association are subsidiary to the Memorandum of Association and should not contradict it.

Correct Answer: True

Solution:

The Articles of Association are rules for internal management and are subordinate to both the Memorandum of Association and the Companies Act.

Correct Answer: True

Solution:

Promoters conduct feasibility studies such as technical, financial, and economic analyses to determine if a business idea can be profitably exploited.

Correct Answer: True

Solution:

A public company raising funds from friends or relatives is required to file a statement in lieu of prospectus, not a full prospectus.

Correct Answer: False

Solution:

The Certificate of Incorporation is necessary as it is conclusive evidence of the company's legal existence, and a company cannot commence business without it.

Correct Answer: True

Solution:

Promoters conduct feasibility studies such as technical, financial, and economic analyses to determine if the business idea can be profitably exploited.

Correct Answer: True

Solution:

A public company is required to file a prospectus with the Registrar when it raises funds from the public.

Correct Answer: True

Solution:

Once issued, the Certificate of Incorporation serves as conclusive evidence of the company's legal existence, regardless of any registration deficiencies.

Correct Answer: False

Solution:

It is not compulsory for a public limited company to file Articles of Association; it may adopt Table F of The Companies Act, 2013.

Correct Answer: True

Solution:

A public company needs to obtain approval from SEBI as part of the capital subscription stage before it can raise funds from the public.

Correct Answer: True

Solution:

A public company is required to file a copy of the prospectus with the Registrar of Companies as part of the capital subscription stage.

Correct Answer: False

Solution:

The Memorandum of Association is a necessary document as it defines the objectives of the company and must be filed for the formation of a company.

Correct Answer: False

Solution:

The Memorandum of Association defines the objectives of the company and its relationship with outsiders, while the Articles of Association define the internal management rules.

Correct Answer: False

Solution:

The Memorandum of Association is the most important document as it defines the objectives of the company, not the Articles of Association.

Correct Answer: False

Solution:

The Articles of Association are subsidiary to the Memorandum of Association and should not contradict or exceed anything stated in the Memorandum.

Correct Answer: False

Solution:

The Memorandum of Association is a necessary document for incorporation as it defines the objectives of the company.

Correct Answer: True

Solution:

Once issued, the Certificate of Incorporation is conclusive evidence of the company's legal existence, regardless of any registration flaws.

Correct Answer: True

Solution:

According to the excerpts, a public company has to undergo the capital subscription stage to begin operations.

Correct Answer: True

Solution:

A public company has to undergo the capital subscription stage to begin operations, which involves raising funds from the public.

Correct Answer: True

Solution:

Preliminary contracts are agreements made by promoters before the company is legally incorporated.

Correct Answer: False

Solution:

The Memorandum of Association defines the objectives of the company and its relationship with outsiders, not the internal management rules.

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