BUSINESS STUDIES XI

CHAPTER -7 FORMATION OF A COMPANY

Short Answer Type Questions

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

Ans. Stages of Formation of company:
Company is formed under the provisions of Indian Company Law. It requires certain
formalities to be completed. Following are main stages of formation of a company:
(i) Promotion Stage
(ii) Incorporation Stage
(iii) Commencement of Business Stage
(i) Promotion Stage: This is first step of formation of a company. At the is stage some
person Think for floating a company. This is the stage of conceiving the idea of business
activity in the form of a company. At this stage the feasibility of a new business is
analysed in detail and on the basis of analysis a decision of formation of a company is
taken. The persons who are conceiving the idea of a new business activities are known as
promoters.
(ii) Incorporation Stage: After taking the decision for formation of a company
promoters initiate for getting the company registered under law so that is may take a legal
status and existence. Incorporation is related to the registration of a company with the
registrar of company of concerned state in which company is to be situated. For
incorporation of a company various legal formalities are completed. After competition of
those legal formalities and scrutiny and satisfaction of registrar of company, a company is
incorporated. For this effect a certificate is issued by the registrar of the company which
is known as ‘certificate of Incorporation’. On issue of this certificate a company comes
into existence and acquires a status of legal separate entity.
In case of a private company all activities of formation of a company are completed after
getting a certificate of incorporation and a private company may start its business. But in
case of public company one more state is required to de completed, which is following:
(iii) Commencement of Business Stage: For a public company some additional
formalities are required to be completed for starting its business after getting a certificate
of incorporation. After completion of some formalities a public company gets a certificate
which is known as ‘certificate of Commencement of Business’. After getting this
certificate a public company may start is business and on receiving this certificate all
formalities of formation (floating) of a public company are completed.
Q.2 List the documents required for the incorporation of company.
Ans. For incorporation of company certain document are required to be filed by the
company with the Registrar of company.
These documents are following:

Presented by Raman Sachdeva

1 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

(i) Memorandum of Association

(ii) Articles of Association
(iii) Prospectus or Statement in Lieu of Prospectus
(i) Memorandum of Association: It is the most important document of a company.
It is compulsorily filed with the registrar of the company for the incorporation of
a company. It is considered as charter of the company. It governs external
relation between the company and outsiders. This should be carefully prepared
because company has to perform its activities within the framework of its
memorandum of association. Any activity which is beyond the limits of
memorandum of association will be considered void and ultra wire. The
alteration in memorandum is also very difficult which requires approval of
certain statutory authorities in many cases. Memorandum of association contains
following six clauses:
a) The Name Clause
b) Registered Office Clause
c) Objects Clause
d) Liability Clause
e) Capital Clause
f) Association Clause
Memorandum of association is signed by at least seven persons in case of a company and at
least by two persons in case of a private company.
(ii) Articles of Association: It contains the rules and procedures regarding internal
management of company. It is also required to be filed with the registrar of the company. It is
a subsidiary document. All rules and provision of it should be within the framework of
memorandum of association. Alteration in articles of association may be made by passing a
special resolution by the members for such effect. A public limited company may also adopt
Table A of Companies Act. In Table A model set of articles is given. When a company is
adopting Table A for its internal management in that case it is not needed to prepare a
separate Articles to Association of file to Registrar of the company.
(iii) Prospectus or in Lieu of Prospectus: It is required for a public company to
issue its shares/debentures to public. Prospectus means 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 shares or debentures of a company. What a public company is
not approaching the public for securing funds (capital), in that case it will have to file a
‘Statement in lieu of Prospectus’ with the Registrar in place of prospectus. Statement in lieu
of prospectus in drafted in accordance with schedule III of the Companies Act. It contains
similar information like prospectus. A private company does not require to file prospectus or
statement is lieu of prospectuses with Registrar of the company.

Presented by Raman Sachdeva

2 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

Besides above three documents following documents are also filed with registrar of company
for incorporation of a company:
A. Consent of proposed directors. The consent of these persons who have agreed to act
as first directors of the company.
B. Agreement, if any, with proposed managing or whole time director.
C. Statutory declaration: A declaration that all legal formalities required for
incorporation of a company have been completed. It should be signed by an advocate
of High Court or Supreme Court or a Charted Accountant or a person named as
director in articles of association or manager or secretary of the company.
Q.3 what is a prospectus? Is it necessary for every company to file a prospectus?
Ans. Meaning of prospectus:
Prospectus is a document required for inviting public for subscription in the securities
(shares/debentures) of the company. A public company normally it funds by issue of its
shares or debenture to public. For this purpose company gives advertisement of this effect.
Prospectus is required to inform the public about all important detail of company so that
investors may take their decision for investment in company’s securities. Prospectus means
any notice, circular, advertisement or document inviting deposits from the public or inviting
offers from the public for the subscription or purchase of any shares or debenture of a
company. Following are important elements of a prospectus
(i) Public should be invited for subscription in the securities (share/debentures) of the
company.
(ii) Invitation must be made by the company or on behalf of the company.
(iii) Invitation should be for subscription or purchase of shares/debentures or any other such
instrument of the company.
Contents of Prospectus:
In prospectus all important information regarding company should be given so that an
investor may take proper investment decision on the basis of well informed particulars.
Normally following details are given in a prospectus:
a) Name and address of registered office of the company.
b) Main objects of the company.
c) Details of shares/debenture i.e. total amount of issue, value of one unit etc.
d) Qualification shares of directors.
e) Name, addresses and occupation of director, managing director or manager.
f) Amount of minimum subscription.
g) The date and time of opening and closing of issue.
h) Amount payable on application and allotment.
i) Time and place at which the audited balance sheets and profit and loss accounts of
company are available for inspection.

Presented by Raman Sachdeva

3 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

Every public company who is intending to issue its shares/debentures to public is required to
file prospectus with the registrar. But if a public company is not intending to raise its funds
by inviting public for subscription and confidant to raise necessary funds ‘(capital) privately’
in that case company may file Statement in lieu of Prosecutes’ with registrar in place of
prospectus. Statement in Lieu of Prospectus is drafted in accordance with particulars given in
Schedule III of Companies Act.
A private company is not required to file Prospectus or Statement in Lieu of Prospectus with
the registrar of the company.
Q.4 Explain term ‘Minimum Subscription’.
Ans. Minimum Subscription:
As per the provision of Companies Act, it is necessary for a company to get subscription
from the public of its issue for certain minimum amount. If it is not getting subscription for
this minimum amount, the company cannot allot the share of that issue. This provision is
included so that a company may not commence its business with inadequate resources. As
per the guideline of SEBI 90% of the amount of capital issued is considered as ‘minimum
subscription’. It a company is not getting applications for its issue for the amount of
minimum subscription or more, it cannot allot the shares of such issue.
When a company is not able to get applications along with cash for ‘minimum subscription’
within 120 days from the date of issue of the prospectus in that case all money received on
application from public will be refunded to applicants within next ten days and no allotment
will be made. The whole issue will be cancelled.
Q.5 Distinguish between ‘Preliminary Contracts’ and ‘Provisional Contracts’.
Ans. When a company is floated different types of contracts are made by the promoters/first
directors for the various requirements related to company affaire. All contracts which are
made before full completion of formation (floating) stages of a company are classified as
‘Preliminary Contracts’ and ‘Provisional Contracts’. Both these contracts are different to each
other. But to understand the difference between these contracts it is important to understand
the meaning and nature of these contracts.
Preliminary Contracts:
All those contracts which are made by the promoters with third parties on behalf of the
company in the stage of promotion of company and before its incorporation are known as
preliminary contracts. These contracts are not legally binding on company because these are
made before the existence of company. If later on after incorporation company desires to
honour these contracts, the company should make fresh contracts for this effect. Preliminary
contracts cannot be ratified by the company. Company is also not liable to make fresh
contracts to replace preliminary contracts. If a company is not making fresh contracts to
replace to replace preliminary contracts, the promoters will be liable personally to third
parties for these contracts.

Presented by Raman Sachdeva

4 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

Provisional Contracts:
What a company enters in some contracts after its incorporation but before getting
‘Certificate of Commencement of Business’ such contracts are known as ‘Provisional
Contracts’. Provisional contracts will be enforceable only after the company get the
certificate of commencement of business.
Difference between ‘Preliminary Contracts’ and ‘Provisional Contracts’:
On the basis of above explanation of nature of these contracts following main difference may
be pointed out between preliminary contracts and provisional contracts:
Basis Preliminary Contracts Provisional Contracts
1. Stage These contracts are made at the These contracts are made by the
promotional stage of the company company after its incorporation but
before its incorporation. before getting certificate of
commencement of business.
2. Parties These contracts are made between These contracts are made between
promoters and third parties. company and third parties.
3. Legal Company is not legally binding with These are binding on the company.
Binding these contracts because these are
company.
4. Enfor- These contracts are not enforceable These are enforceable against company
ceability against company at all. but after getting certificate of
commencement of business.
ss5. These contracts cannot be ratified by These contracts are ratified by the
Retifi- the company. company after getting certificate of
cation commencement of business.
If a company wishes to honour the These contracts will be honoured by
6. Honou- commitment of preliminary contract, it the company.
ring the should make fresh new contracts in
Contract place of these contracts.
If company wishes so, it may deny Company cannot deny these contracts.
7. Denial these contracts altogether.
of
contract If fresh new contract are not made by Promoters are not liable for these
8. Promo- the company in place of preliminary contracts at all.
ters, contract, promoters will be personally
Liability liable to third parties.

LONG ANSWER TYPE QUESTIONS

Q.1 what is meant by the term ‘Promotion’? Discuss the legal position of promoters
with respect to a company promoted by them.s
Ans. Meaning of promotion of company: Promotion is the first step for the formation of a
company. Promotion is an activity of generating an idea of forming a company. In the idea of

Presented by Raman Sachdeva

5 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

generating a company promoters also make necessary arrangements to turn an idea in reality
for formation of company. According to C.W. Gersunbergs “promotion is the discovery of
business opportunities and the subsequent organisation of funds, property and management
ability into business concern for the purpose of making profit there from.”.
Promoters and their position in respect of company:
The persons who under action of form take the job of a company with reference to a given
project and set it in motion and take necessary steps to accomplish that purpose are known as
promoters. Promoters convinces others to join in the process of formation of a company.
According to S. Frances Palmer “Promoter means a person who originates the scheme of
promotion of the company, has the memorandum and articles prepared, executed and
registered and finds the first directors, settles the terms of preliminary contracts and
prospectus (if any) and make arrangements for advertising and circulating the prospectus and
the capital. “It means promoters are the persons who give birth to a company. For giving to a
company promoters has to do many activities.
These activities are following:
Function of Promoters:
(i) Conceiving an idea of business opportunity for starting new business.
(ii) Conducting preliminary analysis and assessing the feasibility of business idea.
(iii) Carrying a detailed investigation to determine nature, scope and requirements of
proposed idea.
(iv) Consulting others and persuading them to act as directors of the company.
(v) Appointing brokers, underwriters, solicitors and bankers of the company.
(vi) Preparing the various documents of company required for its registration like
Memorandum of Association and Articles of Association.
(vii) Preparing prospects of the company.
(viii) Making contracts for purchase of asset for the company.
(ix) Getting company registered.
(x) Making arrangement for allotment of securities of the company.
Position of promoters in respect of a company:
Although promoters are very important person for a company but legally at preliminary stage
at which promoters work company does not come into existence, therefore, promoters are not
having any legal status in the company. They cannot be called as agent, representative or
trustee of the company become at promotion Stage Company is not in existence. The position
and relationship of promoters with company is fiduciary. The relationship of promoters with
company is of confidence and trust. Promoters should work in good faith for the best interest
of the company. Promoters should not misuse their position for personal gains. Promoters
have certain liabilities toward company.
These liabilities are following:

Presented by Raman Sachdeva

6 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

(i) Disclosure of all money received in the process of promotion.

(ii) Depositing all money received on behalf of company is the bank account of the
company.
(iii) To act without any deceit and breach of trust.
(iv)Not to sale his personal property to the company at unreasonable high price.
(v) Surrendering secret profit (if any) to the company.
(vi)Compensating those from whom money is received on the basis of untrue statements
and misrepresentation.
(vii) To be liable for failure to company with the legal formalities.
Q.2 Explain the steps taken by promoters in the promotion of a company.
OR
What are the functions of promoters of a company?
Ans. Steps taken for promotion of a company:
A promoter has to take many steps for promoting a company. These steps are following:
(i) Identification of business opportunity: The first important step for promoting a
company is to think about new business opportunity which may be undertaken by the
company. Business opportunity should be identified carefully considering its
profitability and feasibility.
(ii) Feasibility analysis: When some business idea is identified for a new company and
after it only on the basis of identified idea a company should not be formed. But for
formation of a company the feasibility of identified idea should be studies and
analysed. It should be analysed whether the identified idea may be given a practical
shape or not in form of a company. Feasibility study may be related to various aspects
of business opportunity. These may be following:
(a) Technical feasibility: It should be analysed that what type of technology will be
required for that business activity and whether required technology will be available or
not considering its cost and other aspects.
(b) Financial feasibility: It is related to analysis of financing requirements of the
company. What will be requirement of funds for the company? From what sources and at
what cost these funds will be available.
(c) Economic feasibility: It concerns with profitability of the project. It should be
analysed carefully that what will be the profit prospects from the concern business idea.
(iii) Approval of name of the company: When decision for formation of company is
taken after that the name of the company is to be decided by the promoters. The proposed
name of the company is sent to Registrar of the company for his approval on a prescribed
application from No. 1A. While deciding the name of company a care should be taken
that the proposed name should not be similar to any existing company or any other name

Presented by Raman Sachdeva

7 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

which is prohibited by the law. If Registrar of company finds the name is in order, it will
be approved by the Registrar.
(iv) Fixing up signatories to the Memorandum of Association: Memorandum of
association is an important and compulsory document to be filed with the registrar of
company. On memorandum of association at least seven person in case of public
company and at least two persons in case private company should affix their signature
along with their consent and undertaking of taking qualification share of the company.
Promoters have to find these persons to give their consents and signatures on
memorandum of association. Normally these signatories act as first directors of the
company.
(v) Appointment of professionals: Promoters have to appoint various professionals such
as mercantile bankers, auditors etc. These persons help the promoters in preparation of
various document of company and process of issue of share capital of company.
(vi) Preparation of necessary documents: Some documents, like memorandum of
association, articles of association, consent of directors, argument, statutory declaration
are prepared by the promoters as these are filed with the Registrar of the company for
registration of the company. Necessary fees is also paid for registration by the promoters.
Q.3 what is a ‘memorandum of Association’? Briefly explain its clauses.
Ans. Memorandum of Association: Memorandum of association is the most important
document of a company. It is filed compulsorily with the Registrar of company for
getting company registered. Memorandum of association is considered is considered as
charter of the company. In memorandum of association, important details of company are
given. Therefore, it is important that this document should be prepared very carefully
because amendment in this document requires lot of legal formalities. In memorandum of
association following six clauses are to be given:
(i) The Name Clause: In this clause the name of the company is given. This name is
that which is already approved by the registrar of company. In future company
will be known with this name only. A private company should add the word
‘Private Limited’ at the end of the its name.
(ii) Registered Office Clause: It this clause the name of that state should be given in
which the registered office of the company is proposed to be situated. Exact
address is not required at this stage. But exact address of registered office of the
company should be given to registrar within 30 days from the date of
incorporation of the company.
(iii) Objects
Class: In this clause all those activities and objects of the company should be
given for which company is formed. A company is expected do only those
activities and business which are within the limits of this clause. Any act of

Presented by Raman Sachdeva

8 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

company outside the limits of its object clause will be considered ultra wire. In
this clause company states its main objects and other objects.
(iv)Liability Clause: This clause states the liability of the members of the company.
The liability of the members of the company is limited to extant of the amount of
share capital subscribed by them.
(v) Capital Clause: If this clause states the maximum amount of capital of the
company along with the nature, number and of share is given. It is known as
authorised capital of the company. A company can issue its share capital
maximum to the amount of capital given in this clause during its lifetime.
(vi)Association Clause: In this clause the name of those persons are given who are
signatories on the memorandum of association. The consent of these persons to
subscribe the qualification of shares of the company is also given in this clause. It
should be signed minimum by seven persons in case of a public company and
minimum by two persons in case of a private company.
Q.4 Distinguish between memorandum of association and articles of association of a
company.
Ans. Memorandum of association is an important document of a company. It is compulsorily
filed with registrar of company for getting a company registered. In this all detail of the
company are given. A company is bound to confine its activities within the limits given in the
object clause of it.
Articles of association of a company contain those rules on basis of which the internal
management of the company will be done. Although it is a secondary document of the
company but all provisions of the articles should be within the limits of the facts given in the
memorandum of association.
On the basis of above explanation following differences between memorandum of association
and articles of association may be stated:
Difference between Memorandum of association and Articles of Association:

Basis Memorandum of Association Articles of Association

1. Objectives It given those objectives in details It given the various rules and
for which a company registered. procedures for internal management
of the company. These rules formed
to achieve the objective of
memorandum of association.
2. Position It is a main document of the It is subsidiary document of the
company and subordinates to the company and subordinates to the
Companies Act. memorandum of association.
3. Relationship Memorandum defines the It defines the internal relationship
relationship of company with between member and the company.
outside.

Presented by Raman Sachdeva

9 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

4. Validity Any act performed by a company
beyond its memorandum of
association is invalid. Such acts
cannot be ratified even by
unanimous decision of all
members of company. Such acts
are known as ulrtrawire.
5. Necessity
It is a compulsory document
which should be filed with the
registrar of the company at the
time of registration of the
company. A company cannot be
6. Alteration registered without it.
Alteration in the provisions
(clauses) of memorandum of
association in very difficult and at
time permission of Registrar,
Company Law Board and other
statutory authorities is required
for alteration in memorandum of
association.
Any act performed beyond the
provisions of articles of association
may be ratified by the member of the
company provided it is not violating
the provisions of memorandum of
association
It is not compulsory for a company. A
company may adopt Table A of
Companies Act in place of it.
Alternation in the provisions of
articles of association is not very
difficult. It can be altered by passing
a special resolution by the members
of the company.

Q.5 what is the effect of conclusiveness of the ‘Certificate of Incorporation’ and

‘Commencement of Business’
Ans. Effect of Certificate of Incorporation:
The registration of a company is necessary for its formation. For registration various
formalities are completed by the promoters of the company. On receiving the application for
registration of company, the Registrar of the company scrutinises the various particulars and
on being satisfied with all requirements the Registrar allows the registration of the company.
For its proof a certificate issued by the Registrar to the company which is known as
‘Certification of Incorporation’ of the company. On receiving this certificate company come
into existence having its separate legal entity. Therefore, certificate of incorporation is a
proof of legal birth of a company. After getting this certificate company can act as a separate
legal entity. Following are the effects of getting ‘Certificate of Incorporation:
(i) It is a conclusive proof of existence of a company.
(ii) On receiving this certificate a company gets a separate legal entity with perpetual
succession.
(iii) If a certificate
of incorporation is issued even on the basis wrong information, false representation or
mistake, it does not effect the existence of a company.

Presented by Raman Sachdeva

10 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

(iv)Even if a company is registered and have received certificate of incorporation for

some unlawful objects, it will not effect the existence of company. Only remedy for
correction is that the procedure for winding up of the company should be initiated.
(v) A private company may star its business after getting the certificate of incorporation.
But a public company star its business just after getting this certificate. It requires
another certificate which is known as ‘Certificate of Commencement of Business’ for
starting its business.
Effect of Certification of Commencement of business
After getting a certificate of incorporation a company comes into existence. But public
company cannot start its business just after getting certificate of incorporation. For starting
business, a public company has to complete some addition formalities and have to get another
certification which is known as certificate of commencement of business. After getting the
certificate of commencement of business a public company may legally start its business.
Thus after getting the certificate commencement business all stages of formation of a public
company are completed.
Q.6 Is it necessary for a public company to get share listed on a stock exchange? What
happens if a public company going for a public issue fails to apply to a stock exchange
for permission to deal in its securities or fails to get such permission?
Ans. A public company raises its funds from public by issue of its securities i.e. shares and
debenture. A public company may issue its shares to public for raising funds. For raising fund
from public by issue of shares a company has to company certain formalities. These
formalities are following:
(i) Approval of SEBI: In India SEBI (Securities and Exchange Board of India) is a
regulating authority for company’s matters. When a company wants to raise funds by
issue of share it is required to take prior approval from SEBI for this effect. For
getting SEBI’s approval a company has to issue ‘Disclosure of Information’. It is for
the protection of investors. With this disclosure company discloses all relevant in
formations so that an investor may take a decision of investment in the shares of the
company.
(ii) Filling of prospectus or statement in lieu of prospectus: It is an invitation to the
public to apply for share and debenture of the company. In prospectus all particulars
related to company are given.
(iii) Appointment
of business bankers, brokers, and underwriters: These are appointed to manage
the various aspects of public issue.
(iv)Minimum subscription: For allotment of shares a public company has to company
the condition of minimum subscription. Minimum subscription is 90% of the size of
the issue. It means if a company is not getting application at least for the value of 90%

Presented by Raman Sachdeva

11 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in
 BUSINESS STUDIES XI

of total value of the issue, the company cannot issue the shares to those applicants and
the money received on application must be returned to applicants.
(v) Application to stock exchange: It is also compulsory for a public company to apply
at least in one stock exchange for permission to deal in its shares or debenture. If such
permission is not granted by the stock exchange before the expiry of ten week from
the date of closure of subscription list, the allotment of shares shall become void and
all money received from the applicants will have to be returned to them within eight
days.
Thus, it is clear that a public company is required to get its shares listed in some stock
exchange .If a company fails to apply to a stock exchange for permission to deal in its
securities or fails to get such permission, the company cannot allot its shares and the
application money should be returned to application money should be returned to
applicants with 8 days after the date of closure of issue date.

Presented by Raman Sachdeva

12 B.Com (H), M.Com, MBA, M.Phil, AMT, NET
17/2 (LGF) Jangpura Road, Bhogal
01124377255, 9811957255, 9210461650
www.solutionsacademy.co.in