Chapter 7

Formation of a Company

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7.1 Introduction

A joint stock company is a legal entity. It has its own identity.  Law recognizes a company as an artificial person capable of entering into contracts, own property and do many things that a normal person would do. A company is formed by completing the established producers according to the Indian Companies Act.

7.2 Formation of a Company

There a series of steps involved in the formation of a company. They can be broadly classified into three stages as follows:

I, Promotion

ii. Incorporation

iii. Commencement of business

7.2.1 Promotion of a company

This is the first stage in the formation of a company. Promotion means taking the primary steps in setting up the business. This involves identifying the opportunity, making a detailed study, locating the resources and making decisions on the preliminary agreements. Promotion is skilled activity, requiring in depth knowledge of the business as well as the legal formalities to be completed.

Definition of a Promoter

Promoters are the people who carry out the promotion of a company. They are primarily responsible for the success or failure of a business project. They identify the business idea and initiate the process of forming a company to conduct the business. They investigate the business idea and chart the course of setting up the business. They plans out the sources of finance and other factors of production. Promoter may be an individual, firm, or even an existing company.

Types of Promoters

i. Professional promoter

Professional promoters, as the name indicates are the promoters who will set up the company and hands over charge to Board of directors. Their interest is only in the promotion of the business, not in the running of the business.

ii. Occasional promoter

Occasional promoters do promotional activity whenever they find an opportunity coming their way. They do not generally search for opportunities. They have their own business or other primary job. They do promotion only when the opportunity is very attractive. After completing the promotion they generally return to their main occupation.

iii. Entrepreneur promoter

These are promoters who set up business for themselves. Entrepreneur promoters identify business opportunities, conduct the promotion work and become part of the management of the business they have set up.

iv. Financier promoter

Financiers like banks and other financial institutions that are specialized in the business formalities. They interact with various government authorities involved in the business formation as part of their main business activity. Business promotion becomes a natural extension of the functions that they already involved in. These promoters appoint their directors as long as their finance is used in the business. Once their loans are settled they withdraw from the management of the business.

Functions of a Promoter

Promoter is the person taking all the initial steps in company formation. He has several important functions. Following are the most important functions of a promoter:

i. Discovery of business idea

Promoter is the person who finds out the business idea. He finds out opportunities of profitable investment. He makes a preliminary assessment of the business idea to find out whether it is worth proceeding. He makes a quick assessment of capital required, availability of raw-materials, marketing opportunities etc. Many business proposals are discarded at the preliminary stage itself.

ii. Detailed investigation

This is the second stage in the assessment of business opportunity. A promoter attempts a detailed study only if he finds the project proposal attractive in the preliminary assessment. At this stage every aspect of business is studied in depth, to find as much closer details as possible. Detailed investigation is generally conducted with the help of experts such as professional accountants, consulting engineers or other firms that are specialized in making the feasibility analysis.

A feasibility report contains details of raw materials, availability, price, transportation cost, production details such as machinery, power requirement, production process, man power requirement, marketing opportunity, demand, competition etc.

iii. Assembling of resources

Assembling of resources is the next step if the project proposal is found feasible in the detailed investigation. The assembling function involves procuring the basic necessities for starting the business. Land, buildings and such facilities may be secured at this stage.

iv. Preparing preliminary documents

There are some compulsory documents that for the registration of a company. Memorandum of Association, Articles of Association, and Prospectus are some of the essential documents according the Companies Act. These documents should be submitted to the Registrar Company who has jurisdiction in the state in which the company is to be set up.

v. Entering into preliminary contracts

Promoter enters into preliminary agreements with parties before incorporation of the business. Preliminary agreements are mostly approved by the company after its registration. If the agreements are not approved by the company, promoters become personally liable. Preliminary agreements are generally approved by the company, because of two reasons: First, the promoters continue to have strong influence in the decision making process in the beginning. In fact they usually become first directors of the company. Secondly these agreements are made only for the most essential requirements of the company, for example agreement with the bank to manage the initial public offer (IPO). If a company rejects such essential contracts it will lead to lot of legal complication which is not in the best interest of the company.

vi. Naming the company

Promoters decide the name of the company and submit it for approval. There are several restrictions on selecting the name of a company. Firstly it should not give a false impression that the company is owned by the government. Secondly it should not be the name of an existing company or closely resembling to the name of an existing company.

vii. Appointment of bankers, brokers, solicitors and underwriters

Promoter appoints the bankers, brokers, solicitors and underwriters. These appointments are to be ratified by the company after its incorporation.

In conclusion, promotion is an activity beginning with discovery of a business opportunity, which involves conducting the feasibility study, assembling the resources and registering the business.

Legal Status of Promoter

Promoter performs all the initial functions in the formation of a company. But he does not have the status of an agent of the company. A person cannot represent a company that does not exist. The relationship of principal and agent can begin only after the formation of the company. All the preliminary agreements signed by the promoter must be ratified by the company. Otherwise the promoter will become personally liable to the parties to such contract.

Promoter is also not a trustee of the company in the legal sense. However he is expected to perform his job in good faith.

Observed from the strict legal point of view, starting a company is the riskiest step a person can take. But if the promoter takes reasonable precautions while forming a company, there is almost no risk of new company getting out of control and turning against him.

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