How To Use Promissory Notes for Small Businesses

A promissory note is a legal binding contract between a lender and a borrower. These have been very effective in raising capital for business startups as well as for the purchase or expansion of an existing business. Many times, a startup business must rely on creating promissory notes for family, friends and small investors.

The promissory note is actually an I.O.U. or promise to pay, in an agreed upon manner.

The terms of the loan are always firmly set in the contract. The criteria for setting the terms is entirely up to the parties to the note. It can be set as a balloon payment, which will be paid at a specified time after the business has become successful. This date can be placed at six months, one year or even ten years. A simple promissory note may also be made payable at a certain percentage per month or at a fixed amount until the loan is paid.

The agreed-upon interest will be added in whatever manner the parties choose to do this. Interest rates and payments can be very varied when the contract is between two parties who are personally acquainted.

The note could be for a few hundred or a few thousand dollars. Both parties must agree on the payment plan and the interest rate before the contract is created and signed. You can also stipulate in the agreement whether or not the contract can be sold.

For a simple promissory note, neither an attorney nor a banker need to be involved. It is regarded as a legal, binding, private contract.  All parties to the note should be present at the signing, and each party must receive a copy.

Promissory notes are also used as collateral or sold if the holder of the note needs to create cash flow for business or personal use. In this case, the holder will sell the note for a lesser amount than the face value in order have lump sum cash. If the note is sold, then the payer should be notified about the new ownership.

Promissory notes may be used when purchasing real estate or property. If the bank could not lend the full amount needed, then the seller may accept a promissory note for the balance.

Promissory notes are also an asset if you or your business are the holders of the note. It will be considered as future income.

A promissory note is a payable to bearer on demand document, meaning the document holder is the one who will receive the payments. These notes are sold, traded and exchanged daily in the business world.

In the event of a default on the payments of the note, the document will hold up in court and the payer can be sued to force collection of the amount due.