10 Things to Consider When Incorporating a Private Company
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Every startup, at a certain point of time, has to decide about incorporating a company. Most common type of a company in Pakistan is “private limited company”. If you have decided so, here are the 10 things to consider when incorporating a private company.
(1) Concept of Private Limited Company
A private limited company is a company that is incorporated as such under the Companies Act, 2017 and its Articles of Association provides that:
(1) The company shall not make any invitation to public to subscribe its debt or equity securities (private placement, however, can be an option).
(2) Total number of shareholders shall not exceed fifty (a company with more than 50 shareholders is considered a public company). Where two or more persons hold one or more shares jointly, they are considered a single member for the purposes of this clause.
(3) The right to transfer shares is restricted. A member who desires to transfer his shares shall first offer such shares for sale or gift to existing members. If existing members refuse to accept, shares may be offered to any other person with the approval of the Board of Directors.
So, a private limited company cannot have more than 50 shareholders, cannot go to public to raise funds as in case of listed companies quoted on stock exchange, and shall have to follow certain protocol when a shareholder intends to sell or gift his shares to another person.
(2) Company Name Reservation
Name of the company is one of the most important branding tools.
It should be well thought out. However, it should not be identical with, resemble or similar to the name of a company already in existence.
Before finalizing a name, try Company Name Search at SECP web portal.
When incorporating a private company, SECP may ask about significance of the name. If the company is part of a group, relationship with the group and its brand is its significance. Sponsors can quote the same to SECP by providing supporting documentation such as proof of relationship with the company, board resolution to allow the use of name, etc.
If it is a new company, an example of significance of name can be:
“There is no special significance. It is common word and denotes doing business of all permissible/legal nature.”
A company can change its name after incorporation by passing a special resolution and with the approval of Registrar, SECP. Special resolution is a resolution passed by three-fourth (75%) majority in a shareholders’ meeting.
(3) Number of Members
Number of members/shareholders of a private limited company can be 1 to 50. In case of only 1 member, it will be a Single Member Company (SMC).
A private limited company is required to have at least two directors (SMC will have only one director). Only a member/ shareholder can be director of the company. However, company can appoint an employee director, normally called “Executive Director”. An Executive Director doesn’t need to be a shareholder.
Chief Executive can be a shareholder as well as a non-member. In simple terms, you can appoint anyone as CEO of the company; the CEO doesn’t need to be a shareholder.
An existing shareholder can sell or gift his share to any person using the procedure mentioned at point no. 1. Similarly, company can raise equity from private investors using the same procedure. The company shall first offer the shares to existing shareholders in their equity proportion. For shares refused by existing shareholders, the company can go to private investors with approval of board of directors. In legal terms, it is called the “right issue”.
(4) Documents Required for Incorporation
Sponsors will need to collect/prepare the following information/documents before submitting application for incorporation on prescribed Form-II:
- Mobile number, Email and CNIC of sponsors and proposed CEO
- Proposed name (Form-I) and address of the company
- Authorized and paid-up share capital of the company
- Number of shares to be allotted to each member and per share value
- Principal line of business of proposed company
- Memorandum and Articles of Association of proposed company
- Payment of registration fee
Sponsors are shareholders of the company. CEO can be one of the shareholders or any other person who even does not hold any shares in the company.
Once sponsors have all the information/documents mentioned above, they can complete and submit application for incorporation on specified Form-II to SECP. This application can be submitted using offline mode or online mode.
(5) Proposed Address of Company
A company is required to provide address of its registered office to SECP.
In general, registered office is known as head office. SECP, FBR and all other stakeholders will make communication with the company at address of its registered office.
If sponsors have not established or leased any office for the company at incorporation stage, they may use any address for company incorporation purposes. However, it can be changed later on and should be communicated to SECP.
If address of registered office is changed to another city, members shall approve it through a special resolution. The company is required to communicate change of address to Registrar, SECP on Form-21.
(6) Authorized & Paid-up Share Capital
When incorporating a private company, the sponsors need to decide the amounts of authorized and paid-up share capital.
Authorized share capital is the maximum amount of share capital that a company can issue/raise. It is nominal amount of share capital, not actual. Sponsors don’t need to actually invest this amount in the company.
Amount of authorized share capital is used to calculate SECP fee at the time of incorporation. Amounts of authorized and paid-up share capital can be same or different. However, the amount of paid-up share capital cannot be more than authorized share capital. Authorized share capital can be increased subsequently by paying prescribed fee to SECP.
Paid-up share capital is the amount that sponsors actually invest in the company at the time of incorporation. Sponsors can increase paid-up share capital by making further equity investment in future.
Sponsors also decide the value of each share at the time of incorporation. Company Law does not specify any value per share. Normally, per share value is fixed as a multiple of Rs. 10. For example, authorized share capital of Rs. 1,000,000 can be 100,000 ordinary shares of Rs. 10 each, and paid-up share capital can be Rs. 100,000 i.e. 10,000 ordinary shares of Rs. 10 each.
(7) Type of Share Capital
Companies normally issue ordinary share capital. But this is not the only type of share capital. Different kinds of share capital can be ordinary shares and preference shares.
Preference shares means the shares which carry preferential rights or privileges. Preference can be in terms of:
- right to receive dividend
- right to participate in profits
- right to be paid in the event of winding up of company
- voting and non-voting rights
There can also be more than one class in each kind of capital. For example, Class A preference shares may have preferential voting rights and Class B preference shares may have preferential dividend rights.
There is a popular tem called “sweat equity”. This term is generally used in startups. Sweat equity is issued to a person for his contribution towards business. It is normally non-monetary in nature. Sweat equity is issued to directors or employees at a discount or for consideration other than cash. For example, a technology partner in a startup may be issued 25% sweat equity without any cash investment.
Companies Act, 2017 of Pakistan doesn’t provide any provisions regarding sweat equity. So, sweat equity cannot be provided to directors, employees, etc. Only option available to sponsors is, therefore, managing their relationship through a “Shareholders’ or Founders’ Agreement”, by issuing different kinds and classes of share capital and drafting Articles of Association accordingly.
(8) Principal Objective of Company
A company can engage in any legal business activity. However, at the time of incorporation, sponsors are required to specify principal activity of the company. It is important because principal line of business is included in Memorandum of Association of the company.
A company can do any legal business in addition to the principal line of business. Principal objective of a company refers to that business in which substantial assets are used or substantial revenue is earned. Principal line of business should not be inconsistent or contradictory with name of the company.
Sponsors cannot indulge in the following business activities without obtaining requisite licenses:
- Banking
- Non-banking finance (mutual fund, leasing, investment business, investment advisory, Real Estate Investment Trust management, housing finance, venture capital, discounting services, microfinance or micro-credit business)
- Insurance
- Modaraba management
- Stock brokerage
- Forex
- Security guard services
- Agency management
(9) Memorandum & Articles of Association
Memorandum and Articles of Association are bye-laws of the company.
Memorandum of Association provides information about principal line of business of the company.
Articles of Association provides rules of business of the company. Particularly, it provides rules regarding transfer of shares, directors, meetings, management & administration, duties and powers of the board of directors, chief executive, finances, accounts, audit, and winding up.
At incorporation time, sponsors can opt a short version of Memorandum & Articles of Association if they intend to include standard set of rules as per Companies Act, 2017. If they want to modify certain rules, it is recommended to adopt detailed versions.
Therefore, sponsors should carefully consider the drafting of Memorandum & Articles of Association when incorporating a private company.
(10) Conversion Options
Private limited company is not the only type of legal structure used by businesses in Pakistan.
Partnership, Sole Proprietorship, and Public Limited Company are other options.
A partnership can be converted into a private limited company. However, a private limited company cannot be converted back into a partnership.
Similarly, a private limited company can be converted into a public limited company, and vice versa.
Therefore, if sponsors are already running a business, they must consider the conversion options available. Conversion means assets, liabilities, equity, portfolio and goodwill of existing business shall transfer to the converted business.
This was the professional and practical insight about most important 10 things to consider when incorporating a private company in Pakistan. If you have more questions regarding incorporation related matters, comment below or contact us.
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