While incorporating a private limited company, most people falter at the sight of the Rs. 1 lakh authorized capital which every company must have in accordance with the requirements under the Companies Act, 1956, as amended (“Companies Act”).
Common questions include:
(a) Do you need to deposit Rs. 1 lakh in a fixed deposit account in a bank?
(b) Do I need to wait till I can collect Rs. 1 lakh in cash?
Due to this and many other common misconceptions that many entrepreneurs have, many people prefer to form a proprietorship concern. The principal advantage of incorporating a private limited company is the limited liability of Companies vis-à-vis a proprietorship concern or a partnership firm. It is important to understand that it is not necessary to have Rs. 1 lakh either in cash or in a fixed deposit account when starting a company.
So then what is this Rs. 1 lakh requirement?
The requirement of Rs. 1 lakh is with respect to the authorised share capital of the company. Authorised share capital essentially represents the aggregate value of shares which can be issued by a company. In contrast, issued and subscribed share capital represents the aggregate value of shares which have been issued by the company.
The issued subscribed share capital has to be within the limits of the authorised share capital. In India, under the Companies Act at the time of incorporation of a company the requirement of Rs. 1 lakh is with respect to the minimum authorised share capital as well as the issued and subscribed share capital. So in essence, one can form a company today with Rs. 1 lakh in authorised as well as issued, subscribed share capital, with that entire amount allotted to shareholders. But such amount need not be invested in cash upfront.
Principally, as per the accounting rules and standards prevalent in India, at the end of one (1) year, when the company draws up its accounts, the authorised capital is represented as Rs. 1 lakh on the liability side. To counter that, on the asset side, the company needs to show assets worth Rs. 1 lakh, which could be computer, machinery, intellectual property (like a trademark, valued by a valuer) or cash / bank account. Typically, one (1) year old companies have much more than Rs. 1 lakh in accumulated cash / reserves.
Do not hesitate to form a Company just because you do not have Rs. 1 lakh in ready cash. It is perfectly alright to start a Company while you are bootstrapped. Your accounts at the end of one year can reflect Rs. 1 lakh authorized capital and balance it against the Company assets as illustrated above. At the cost of repetition, it is just an accounting requirement, and not a physical requirement to have that quantum of cash in the bank.
If it is just an accounting treatment, why not have a higher authorized capital?
The main reason for not doing so is due to cost of bearing higher stamp duty. While stamp duty varies from state to state it is dependent on the value of the authorized capital of the Company, as entered in the memorandum of association (“MoA”) and the Form 1 (which is required to be filed at the time of submitting the MoA).
As and when due to operational efficiency and requirements of investment, the authorised share capital of a company may be increased by paying additional stamp duty. It is typical for startup companies to incorporate a company with the minimum mandatory authorised share capital which is increased over time.
If I am investing Rs. 10 lakh, do I need to issue shares worth Rs. 10 lakhs?
The value of the authorised share capital has nothing to do with the amount of investment in the company. Some entrepreneurs believe that if they are investing Rs. 10 lakhs in a company, they need to have an authorized capital also of Rs. 10 lakh.
Investment into a company does not represent the share capital of the company. It is possible to have investment in a company for an amount of Rs. 10 lakhs where the authorised share capital of the company is only Rs. 1 lakh. Since investment into a company does not represent the share capital, companies such as Walmart need not issue share worth half a trillon dollars.
The money invested into a company can (if you want) be treated as a loan to the company, or it need not be shown at all – it can be simply shown as an expense in the accounts of the investor.
[About the author: Contributed by Hrishikesh Datar, founder of vakilsearch.com, online legal services provider (Legal Advice, Legal Documents & more.]
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