Understanding Company Structures, Types, and Formation in India
According to Section 2 (20) of the Company Act 2013, “Company means a company incorporated under this Act or any previous Company Law.” In general, a company is an artificial person, created by law, that has a separate legal entity, perpetual succession, and common seal and has limited liability. It is a voluntary association of persons who together contribute to the capital of the company to do business. Generally, the capital of a company is divided into small parts known as shares, the ownership of which is transferable subject to certain terms and conditions.
Characteristics of a Company
(i) Incorporated Association: A company comes into existence through the operation of law. Therefore, its incorporation under the Companies Act is a must. Without such registration, no company can come into existence.
(ii) Separate Legal Entity: A company has a separate legal entity, which is not affected by changes in the ownership. Therefore, being a separate entity, a company can contract, sue, and be sued in its corporate name and capacity.
(iii) Artificial Person: A company is an artificial and juristic person that is created by law.
(iv) Limited Liability: Every shareholder of a company has limited liability. His liability is limited to the extent of the unpaid value of the shares held by him. If such shares are fully paid up, he is subject to no further liability.
(v) Perpetual Existence: The existence of a company is not affected by the death, retirement, and insolvency of its members. That is, the life of a company remains unaffected by the life and the tenure of its members in the company. The life of a company is infinite until it is properly wound up as per the Companies Act.
(vi) Common Seal: The company is not a natural person and has no physical existence. Hence, it cannot put its signature. Thus, the common seal acts as an official signature of a company that validates the official documents.
(vii) Management and Ownership: A company is not managed by all members but by their elected representatives called Directors. Thus, management and ownership are different.
(viii) Transferability of Shares: Shares of a company are freely transferable, except in the case of private companies. Transfer of shares of private companies is regulated by Articles of Association.
Features of a Company
- Separate legal entity: The company is separate from its owner. This means the owner has the right to sue and be sued in their name, enter into contracts, and own assets and properties.
- Limited liability: The liability of a company’s shareholders or owners is limited to the amount of capital they have invested in the company. This means their assets are not at risk if the company incurs debts or is sued.
- Perpetual succession: It has a perpetual succession, meaning it can continue to exist even if the ownership or management changes.
- Centralized management: A company’s management is centralized and usually conducted by a board of directors or a group of executives. The shareholders or owners have limited involvement in the company’s day-to-day operations.
- Transferability of ownership: Shares represent the ownership of the business. They can be bought and sold on a stock exchange or privately. This means the company’s ownership is easily transferable without affecting its operations or existence.
Types of Companies
Here is a brief overview of different types of companies in India:
Public Limited Company
In this company, the general public of India holds shares of the company, and they can easily trade these shares as it is listed on the stock exchange market. Though there is no limitation on the number of shareholders, at least 7 members must be present to establish this company.
Private Limited Company
In India, a private limited company is a privately owned business entity with limited liability. This type of company has a maximum of 200 shareholders. The shares of this company cannot be traded or transferred publicly.
Companies Limited by Guarantee
Also known as a Guarantee Company, this company’s members promise to contribute a specific amount to the company’s assets if it closes down. This promise limits their financial responsibility. The amount each member commits to determines their ownership stake in the company.
Companies Limited By Shares
In a company limited by shares, the Memorandum of Association (MOA) restricts the liability of its members. Members are only liable for any outstanding amounts on the shares they hold. These companies issue shares via IPO (Initial Public Offering). The ownership of a shareholder in the company is determined by the equity shares they possess.
Holding Company
A holding company is a company that owns one or more other companies. It is like a parent company, and the companies it owns are called subsidiaries. The holding company either owns more than half of another company’s shares or controls its board of directors, either directly or through another company.
Subsidiary Company
A subsidiary company is owned and controlled by another company, known as a parent or holding company. The parent company can be the sole owner or one of several owners of the subsidiary.
Listed Company
A listed company is one of the types of public sector companies whose shares are listed on the stock exchange market and are traded publicly.
Unlisted Company
Unlisted companies are not listed on the stock market, so they are privately owned. These companies cannot raise funds publicly and become capital investors. Their shares trade ‘over the counter’, where the agreements of the deal are tailored to the buyers and sellers, therefore avoiding exchange regulations. Unlisted companies have more control over their operations.
Government Company
When the central or state government or both hold more than 50% of the share capital of a company, it is known as a government company.
Foreign Company
Foreign companies are those companies that are incorporated outside India. They conduct business operations in India, either on their own or by collaborating with other companies.
Associate Company
An associate company is a business that other companies have a big influence on. To influence companies, one needs to own at least 20% of that company’s shares. A joint venture company is a type of associate company.
Dormant Company
A dormant company is one that is not doing any business for a while, usually for two consecutive financial years. It is still registered but not active because it might be waiting to start something new or pausing the operations temporarily. However, these companies still have some duties, like keeping a minimum number of directors and filing certain documents, even if dormant.
The formation of a company goes through a number of steps, starting from idea generation to commencing of the business. This whole process can be broken down into 4 major phases or steps, which we will be discussing in the lines below. The major steps in the formation of a company are as follows: Promotion stage, Registration stage, Incorporation stage, Commencement of Business stage. Let us discuss these steps in detail.
Promotion Stage
Promotion is the first step in the formation of a company. In this phase, the idea of starting a business is converted into reality with the help of promoters of the business idea. In this stage, the ideas are executed. The promotion stage consists of the following steps:
- Identify the business opportunity and decide on the type of business that needs to be done.
- Perform a feasibility study and determine the economic, technical, and legal aspects of executing the business.
- Interest shown by promoters towards the business idea and supply of capital and other necessary procedures to start the business.
Registration Stage
The registration stage is the second part of the formation process. In this stage, the company gets registered, which brings the company into existence. A company is said to be in existence if it is registered as per the Companies Act, 2013. In order to get a company registered, some documents need to be provided to the Registrar of Companies. There are several steps involved in the registration phase, and are as follows:
- Memorandum of Association: A memorandum of association (MoA) must be signed by the founders of the company. A minimum of 7 members are required in the case of a public company and 2 in the case of a private company. The MoA must be properly registered and stamped.
- Article of Association: Article of Association (AoA) is also required to be signed and submitted. All members who previously signed MoA should also be signing the AoA.
- Directors of the company should provide written consent agreeing to be directors, which should be filed with the Registrar of Companies (RoC). The notice of address of the office needs to be filed.
- A statutory declaration should be made by any advocate of either the High Court or Supreme Court, or a person of the capacity of Director, Secretary, or Managing Director. This declaration shall be filed with the RoC.
Certificate of Incorporation
A certificate of incorporation is issued when the registrar is satisfied with the documents provided. This certificate validates the establishment of the company in the records.
Certificate of Commencement of Business
A certificate of commencement of business is required for a public company to start doing business, while a private company can start business once it has received the certificate of incorporation. Public companies receiving the certificate of incorporation can issue a prospectus in order to make the public subscribe to the share for raising capital. Once all the minimum number of required shares have been subscribed, a letter should be sent to the registrar along with a bank document stating the receiving of the money.
Clauses of the Memorandum of Association
Explain the various clauses of the Memorandum of Association of a Company. A memorandum of association (MoA) is the most essential document in the formation of a company as it highlights the company’s main objectives and goals. The MoA regulates the activities of the incorporated company in such a manner that the company can legally undertake only those activities that are mentioned in the MoA. This document must be signed by at least seven members in the case of a public company and by two persons in the case of a private company. The following are the main clauses of the MoA.
The Name Clause
This includes the name of the company which has already been approved by the registrar of companies. It is the name by which the company will be known.
Registered-Office Clause
This clause mentions the name of the state where the registered office of the company is situated. It is not mandatory to submit the exact address of the registered office at this stage. However, the address needs to be submitted within 30 days of incorporation of the company.
Objects Clause
This is the most important clause in the MoA as it defines the main objective of the company for which it was formed. The company cannot undertake activities that are not stated in the objects clause. The objects clause is divided into the following two sub-clauses.
- The main objects: This sub-clause lists the main objects for which the company is formed. Any clause that is essential for the achievement of the main objectives is considered valid even if it is not contained in the sub-clause.
- Other objects: Objects that are not included in the main-objects clause can be included in this sub-clause. If a company wants to initiate a business activity that is mentioned in this clause, it is required to pass either an ordinary resolution or a special resolution to get the consent of the central government.
Liability Clause
This clause states the liability of each shareholder according to the amount unpaid by them for the shares they own.
Capital Clause
This clause defines the authorized capital of the company which it can raise through the issue of shares. It also states the division of the number of shares.
Association Clause
This clause contains the statement by the signatories to the MoA giving their approval to be a part of the company. They also give their consent to buy the qualification shares of the company.
Articles of Association
Define ‘Articles of Association’. Explain in detail the contents in Articles of Association. [The Articles of Association is a secondary, subsidiary, and subordinate document which contains the by-laws, rules, and regulations for the internal management of a company. It lays down the rules for carrying out the objects of the company. These rules are meant for the internal management of the company within the area defined by the Memorandum of Association. According to Section 2(5) of the Companies Act, 2013, “Articles mean the articles Of the association of a company as originally framed or as altered from time to time in pursuance Of any previous companies law or of this Act” According to Lord Justice Bowen, “The articles of association are internal regulations of the company and are for the benefits of members of the company.
Contents
The Articles of Association lays down the procedure and rules regarding the following matters or issues:
- Company’s share capital and its division into the equity shares and preference shares. Rights of shareholders, a variation of these rights.
- Rights of each class of shareholders and procedure for changing their rights.
- Procedure relating to allotment and calls on Shares.
- Rules relating to transfer and transmission of shares.
- Lien on shares.
- Increase, reduction, or alteration of share capital.
- Procedure for conversion of shares into stock.
- Share warrants.
- Conducting General Meetings.
- Voting rights of members, proxies, and polls.
Definition of Private Company
Section 2(68) of the Companies Act, 2013 defines private companies. According to that, private companies are those companies whose articles of association restrict the transferability of shares and prevent the public at large from subscribing to them. This is the basic criterion that differentiates private companies from public companies. The Section further says private companies can have a maximum of 200 members (except for One Person Companies). This number does not include present and former employees who are also members. Moreover, more than two persons who own shares jointly are treated as a single member.
Features of Private Companies
These are some features that distinguish private companies from other types of companies:
- No minimum capital required: There was a minimum paid-up share capital requirement of Rs. 1 lakh previously, but that is omitted.
- Minimum 2 and maximum 200 members: A private company can have a minimum of just two members (but just one is enough if it is a One Person Company), and a maximum of up to 200 members.
- Transferability of shares restricted: Private companies cannot freely transfer their shares to the public like public companies. This is why stock exchanges never list private companies.
- “Private Limited”: All private companies must include the words “Private Limited” or “Pvt. Ltd.” in their names.
- Privileges and exemptions: Since private companies do not freely transfer their shares and involve limited interest by members, the law has granted them several exemptions that public companies do not enjoy.
Types of Private Companies
Private companies are of three types depending on their members’ liabilities:
- Limited by shares: The liability of the members is limited to the amount unpaid to the company with respect to the shares held by them.
- Limited by guarantee: Here the members’ liabilities are limited to the amount of money they guarantee to pay in case the company is wound-up.
- Unlimited liability: The liability of members is unlimited in this type of private company. Personal assets of members can be attached and sold when the company is being wound-up.
In terms of the number of members, a private company can also be a One Person Company. These types of companies have just one member/shareholder as their promoter. The new Companies Act of 2013 introduced such types of companies.
The stages of forming a private company include
- Promotion: The first stage of forming a company, when the company is created and its purpose is determined.
- Incorporation: The legal process of forming a company, which involves:
- Naming the company
- Filling out a registration form
- Preparing and submitting documents for registration
- Obtaining a commencement certificate
- Registration: The process of submitting an application to the Registrar of Companies to register the company.
- Compliance: The legal and regulatory obligations that a private company must adhere to, such as:
- Maintaining financial records
- Conducting annual general meetings
- Filing annual returns with the Registrar of Companies (ROC)
What is a Share Capital Account?
A company is an artificial person and therefore they are unable to generate their own capital and that capital has to be collected from different persons. The persons from whom the capital is collected are called the shareholders and the amount that they contribute towards the business is referred to as the share capital. The number of shareholders being too many makes it impossible to open different capital accounts for each of the members. Therefore, the different contributions of capital from the shareholders are considered under a common capital account which is known as the Share Capital Account.
Share Capital Structure
The structure of shareholders’ capital refers to the composition and arrangement of different types of shares issued by a company. It represents how the company’s capital is divided among shareholders and reflects the ownership and funding structure of the company. The capital structure represents the structure of shareholders’ funds in the balance sheet, typically consisting of various types of shares, such as:
- Equity Shares (common shares): These are the most common type of shares that a company issues. They represent ownership in the company and provide shareholders with voting rights and a share in the company’s profits through dividends.
- Preference Shares: These shares come with preferential rights and privileges over equity shares. Preference shareholders have a fixed dividend rate and receive dividends before equity shareholders. They also have priority in receiving capital in case of liquidation but usually do not possess voting rights.
- Cumulative Preference Shares: These shares carry a right to accumulate unpaid dividends if the company is unable to pay dividends in a particular year. The accumulated dividends must be paid to cumulative preference shareholders before any dividends are paid to equity shareholders.
- Redeemable Shares: These shares can be repurchased or redeemed by the company at a future date or upon meeting certain conditions. Redeemable shares provide flexibility to the company in managing its capital structure.
- Non-Voting Shares: Some companies issue non-voting shares, which do not carry voting rights. These shares are typically offered to investors who seek capital appreciation but are not concerned with voting in company matters.
The Companies Act of 2013 has several provisions for valid calls on shares, including:
- Uniform basis: Calls must be made on a uniform basis for all shares in the same class. This means that the shares must have the same nominal value and paid-up capital.
- Board resolution: The call must be made by a resolution of the Board of Directors, passed at a duly convened meeting.
- Articles of the company: The call must be made in accordance with the provisions of the company’s articles. If there are no articles, the call must be made in accordance with Table “A” of the First Schedule to the Act.
- Bonafide: The call must be made in good faith and in the best interest of the company.
- Time and place of payment: The time and place of payment must be specified by the Board’s resolutions or fixed separately by the directors.
- Interval between calls: There should be at least one month between two calls.
- Notice to shareholders: At least 14 days should be provided to each member for the call, with the amount, date, and place of payment specified.
- Joint and several liability: Joint shareholders are jointly and severally liable for the payment of payment.
What is a Security?
A security is a financial instrument, typically any financial asset that can be traded. The nature of what can and can’t be called a security generally depends on the jurisdiction in which the assets are being traded. In the United States, the term broadly covers all traded financial assets and breaks such assets down into three primary categories:
- Equity securities – which include stock.
- Debt securities – which include bonds and banknotes.
- Derivatives – which include options and futures.
Types of Securities
Equity securities
Equity almost always refers to stocks and a share of ownership in a company (which is possessed by the shareholder). Equity securities usually generate regular earnings for shareholders in the form of dividends. An equity security does, however, rise and fall in value in accord with the financial markets and the company’s fortunes.
Debt securities
Debt securities differ from equity securities in an important way; they involve borrowed money and the selling of a security. They are issued by an individual, company, or government and sold to another party for a certain amount, with a promise of repayment plus interest. They include a fixed amount (that must be repaid), a specified rate of interest, and a maturity date (the date when the total amount of the security must be paid by). Bonds, bank notes (or promissory notes), and Treasury notes are all examples of debt securities. They all are agreements made between two parties for an amount to be borrowed and paid back – with interest – at a previously-established time.
Derivatives
Derivatives are a slightly different type of security because their value is based on an underlying asset that is then purchased and repaid, with the price, interest, and maturity date all specified at the time of the initial transaction. The individual selling the derivative doesn’t need to own the underlying asset outright. The seller can simply pay the buyer back with enough cash to purchase the underlying asset or by offering another derivative that satisfies the debt owed on the first.
A sick company is a company that has accumulated losses equal to or greater than its net worth at the end of a financial year. The Sick Industrial Companies (Special Provisions) Act, 1985 was enacted to identify and help revive sick companies. The act defined a sick company as: A company registered for at least five years. Has accumulated losses equal to or greater than its net worth at the end of a financial year. To apply for revival and rehabilitation, a company must: a) File an application with the tribunal within 60 days of being identified as sick. b) Include audited financial statements and a draft of the revival and rehabilitation scheme. If the creditors do not approve the scheme, the company will be wound up. The administrator will submit a report within 15 days, and the tribunal will order the company to be wound up. A company that is wound up ceases to do business as usual. Its sole purpose is to sell off stock, pay off creditors, and distribute any remaining assets.
The process of registering a company in India is governed by the Companies Act 2013 and is handled by the Ministry of Corporate Affairs (MCA). The steps for registering a company are: 1) Obtain a Director Identification Number (DIN) 2) Obtain a Digital Signature Certificate (DSC) 3) Apply for company name approval 4) Prepare the Memorandum of Association (MoA) and Articles of Association (AOA) 5) Have the required number of people subscribe to the MoA 6) File the company registration form (SPICe+) on the MCA portal. 7) Upload and submit the required documents and fees. 8) Receive a Certificate of Incorporation from the ROC. The company will become a separate legal entity after receiving the Certificate of Incorporation. Here are some other things to note about the company registration process: 1) The company’s structure must be decided before registration. This includes whether the company will be an OPC, LLP, PLC, or Public Limited Company 2) The MoA defines the company’s scope of actions, including its name, location, authorized share capital, and members’ liability. 3) The subscribers to the MoA must each take at least one share in the company’s capital. 4) The company’s proposed directors and the subscribers of the MoA and AOA must all obtain a DSC. The company’s documents should be self-attested and as up-to-date as possible.
The word ‘debenture’ itself is a derivation of the Latin word ‘debere’ which means to borrow or loan. Debentures are written instruments of debt that companies issue under their common seal. They are similar to a loan certificate. Debentures are issued to the public as a contract of repayment of money borrowed from them. These debentures are for a fixed period and a fixed interest rate that can be payable yearly or half-yearly. Debentures are also offered to the public at large, like equity shares. Debentures are actually the most common way for large companies to borrow money.
A charitable company is registered as a non-profit organization (NPO) under Section 8 of the Companies Act, 2013. These companies are registered with the Ministry of Corporate Affairs. Definition of Section 8 Company: The Companies Act defines a Section 8 company as one whose objectives are to promote fields of arts, commerce, science, research, education, sports, charity, social welfare, religion, environment protection, or other similar objectives. These companies also apply their profits towards the furtherance of their cause and do not pay any dividend to their members. These companies were previously defined under Section 25 of the Companies Act, 1956 with more or less the same provisions. The new Act has, however, prescribed more objectives that Section 8 companies can have. Famous examples of Section 8 companies include the Federation of Indian Chambers of Commerce and Industry (FICCI) and the Confederation of Indian Industries (CII). The objective of these companies is facilitating the growth of trade and commerce in India.
Share buyback is the practice where companies decide to purchase their own shares from their existing shareholders either through a tender offer or through an open market. In such a situation, the price of concerning shares is higher than the prevailing market price. When companies decide to opt for the open market mechanism to repurchase shares, they can do so through the secondary market. On the other hand, those who choose the tender offer can avail the same by submitting or tendering a portion of their shares within a given period. Alternatively, it can be looked at as a means to reward existing shareholders other than offering timely dividends. However, company owners may have several reasons for repurchasing their stocks. Individuals should make a point to find out the underlying causes to make the most of such decisions and also to benefit from them accordingly.
A prospectus is defined as a legal document describing a company’s securities that have been put on sale. The prospectus generally discloses the company’s operations along with the purpose of the securities being offered.
Types of Prospectus
- Deemed Prospectus – As per Section 25(1) of the Companies Act, 2013, a document will be deemed to be a prospectus if the company agrees to allot or offer securities to the public.
- Abridged Prospectus – It is defined as the brief summary of the prospectus, which includes all useful and materialistic information filed before the registrar. As per Section 33(1) of the Companies Act, 2013, an abridged prospectus must be included with the documents for the purchase of securities issued by a company.
- Red Herring Prospectus – It is the prospectus that is required to be filed before the registrar prior to the offer. The prospectus generally lacks information such as the particular price or quantum of securities being offered.
- Shelf Prospectus – It is defined as the prospectus issued by a company, bank, or financial institution for more than one class of securities.