If another party owes you money, there are many options at your disposal to ensure collection of the owed amount. Alternatively, if you need a cash infusion, there are ways for you to borrow money from a creditor that trusts you to pay back a specified amount. For example, one option is an IOU, which is the most informal note documenting a debt. On the other side of the spectrum, you could use a loan contract, which is comparatively rigid in its terms.
Sometimes you might prefer a financial instrument that lies somewhere in the middle; one such document is a promissory note. Below, we clarify the unique nature and give some common uses of promissory notes.
Promissory Notes Explained
A promissory note is a written agreement by one party — the party that owes money — to pay back the party that is owed money (the payee) at a specific time and amount. It usually includes the principal amount, which is the initial amount borrowed, and any interest the payee wishes to incur from the issuer. The promissory note is possessed by the party that is owed money and, once it is paid, returned to the issuer.
An important difference between a promissory note and a loan is that a promissory note does not often include manners of recourse for the payee to enforce if the issuer fails to pay the specified amount in the time frame. In that respect, it carries an amount of risk that loan contracts do not.
Common Uses for Promissory Notes
Businesses commonly use promissory notes for immediate, short-term funding. For example, if a business is delayed collecting money owed for products sold to customers, they might issue a promissory note to a creditor promising money by a certain date.
In the past, such documented agreements were used as a form of private money. Today, promissory notes are regulated more thoroughly, but there is still an amount of risk in using them that does not exist in loans, which is why companies that could not otherwise secure loans or bonds use promissory notes.
Another common use for promissory notes is for students seeking loans to pay for their higher education. Both private lenders and the federal government hold promissory notes in exchange for students and ex-students promising to pay the principal amount plus regular interest.
If a promissory note meets certain stipulations, it can also be legally used as a negotiable instrument in financial transactions.
Although promissory notes have certain attractive features, they are not the solution to every debt. If you are seeking assistance with raising money for your startup, get in touch with Trembly Law Firm today. We have helped countless businesses and we can help yours.