Incorporation of business

<< TYPES OF BUSINESS ORGANIZATIONS

Authorized Share Capital, Issued Share Capital >>

Financial Statement Analysis-FIN621

Lesson-26

TYPES OF BUSINESS ORGANIZATIONS

(Continued)

There are also certain closely held companies which are small businesses, restricting

ownership to a limited group of stockholders (private). They are not publicly owned.

A public limited company has perpetual existence and continuous life (through issue of

transferable shares). Unlike partnerships, corporations do not dissolve at the death of any of its

directors/shareholders.

Board of directors is elected by stockholders of the Corporation. Managers of business are

hired and appointed by the Board. Individual stockholders can be hired for management of the business.

Ownership and management of public limited companies are however separate. There can be outside

directors as well.

Costs of incorporating a business as public limited company are charged to an assets

account called organization or incorporation costs. These appear in balance sheets under the caption

"other Assets". These are written-off over a five year period.

Incorporation of business

Approval of competent authority and listing on Stock Exchange is the first step. Approval

of Corporate Law Authority under Companies Ordinance, 1984 for issue of Prospectus is also a pre-

requisite to incorporation of a business as public limited company. Clearance of Prospectus by Stock

Exchange is the next step. However, approval and clearance is no guarantee of correctness of Prospectus

contents. Filing of Prospectus and related documents with Registrar of Companies follows. Prospectus

gives interalia, objectives and operations of the entity, capital structure, Basis of Allotment of Shares

etc.

Example of Capital Structure:

Authorized share capital Rs.300 m divided into 30 m shares of Rs.10 each. Capital

initially proposed to be raised: initial equity capital Rs.200 m. Initial subscription by Sponsors and First

Subscribers: Rs.150 m divided into 15 m share of Rs.10 each. Capital offered to public: Rs.50 m

divided into 2 m shares of Rs.10 each.

Formation of a Company

In case of private limited company, any two members and in case of public limited company, any seven

members can subscribe their names in Memorandum and Articles of association along with other

requirements of the Companies Ordinance 1984; can apply to Security and Exchange Commission for

registration of the company.

Memorandum of association:

Memorandum of association contains the following clauses:

· Name of the company with the word "Limited" as the last word of the name, in case of public

limited and the parenthesis and the word "(Private Limited)" as the last word of the name, in

case of private limited company.

· Place of registered office of the company.

· Objective of the company.

· Amount of share capital with which company proposes to be registered and division in to

number of shares.

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Financial Statement Analysis-FIN621

No subscriber of the company shall take less than one share.

Each subscriber of the memorandum shall write opposite to his name, the number of shares held

by him.

Articles Of Association

Article of association is a document that contains all the policies and other matters which are

necessary to run the business of the company.

This is also signed by all the members of the company.

When Security and Exchange Commission is satisfied that all the requirements of the Companies

Ordinance have been complied with, it issued certificate of incorporation to the company. This

certificate is evidence that a separate legal entity has come in to existence.

Certificate of Incorporation/Registration

When Security and Exchange Commission of Pakistan receives application for registration of a

company, the registrar of SECP makes investigation in respect of compliance with legal requirements.

When he is satisfied that all legal requirements are complied with. He issues a Certificate of

Incorporation/registration to the company. This certificate is evidence that a separate legal entity has

formed. The company, after incorporation/Registration has the right to sue and to be sued in its own

name.

Two types of stock/shareholders:

The two types of stockholders or shareholders are common and preferred shareholders.

Common stockholders have right to vote in election of directors and in other important

actions e.g. mergers, acquisitions, selection of auditors, raising capital etc. They have right to receive

dividends if authorized or declared by Board of Directors. No dividend is given on profit on sale of

assets, or if the business goes into loss. No interest is given on unpaid dividend. Dividends are declared

in General Meeting, but these should not exceed the amount recommended by Board of Directors.

Common shareholders have right over assets if company is liquidated, only after

creditors and preferred shareholders are paid in full. They are therefore called residual claimants.

Preferred shares have priority or preference over common stock in receiving dividends and in the event

of liquidation. Dividend is fixed in this case, and does not increase with increase in earnings. Conditions

of declaration of dividends by Board of Directors, however exists in this case also. Preferred

stockholders have no voting rights. Preferred shares are callable or redeemable at higher price by the

company issuing these. Thus these have characteristics of both debt and equity's, and are sometimes

referred to as Hybrid Securities.

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