5 Things You Should Know About Promissory Notes

It is common knowledge that when you approach a lender to borrow some money, there has to be some form of agreement as to how and when you intend to pay back the money. You can also call it a contract. A promissory note works on a similar principle. It is basically an agreement signed by you promising to pay back the borrowed money to your lender within a specified period of time. Businesses, companies, and individuals can use promising notes. Sometimes the note is also called a personal note, promise to pay, loan agreement, and notes payable, just to name a few common alternative names. This being only a tip of the iceberg, here are 5 things you should know about promissory notes.

1. They Are Legally Binding

The first important thing to know is that notes payables are legally binding. They are governed by the state of law and enforced in a similar manner to other legally binding agreements or contracts. In some situations, the promise to pay is regulated by certain legal restrictions. For instance, some restrictions may apply for secured loans and interest rates. Provided, there is mutual understanding between the parties involved, a promise to pay note can always be modified some point down the line.

2. They Are Flexible

Flexibility is arguably the most significant benefit of promissory notes. This is especially advantageous to the borrower. It gives you the flexibility to specify how you intend to make the payments. For instance, you can choose to pay the amount in a lump sum or using several installments made monthly, quarterly or semi-annually as per your convenience. Nonetheless, the terms have to be specified on the agreement form.

3. They Are Often Brief

Unlike the case with conventional loan documents, promissory notes are mostly brief and to the point. This means less cost for both the lender and the borrower in terms of document preparation and the time spent reading the terms to understand the terms.  

4. They Are Increase Trust

If you’re a business or corporate entity looking for investors, a convertible promissory note can come in handy to entice them. This is because some investors tend to shy away from companies where there’s not enough proof that their investment will pay off. Some may take time to believe in your equity. With a convertible promise-to-pay note, however, you can increase an investor’s confidence in your company, especially since it is legally binding. You can do so by allowing such an investor to convert to preferred interest or stock later in time, even in case of an unforeseeable event.

5. They Have A Few Drawbacks Too

Generally, personal notes have their fair share of drawbacks. There are some instances where the note may not be your best financial option. For instance, you may want to consider other options if your company does not have a substantial cash flow to take care of debt financing. In most cases, also, unsecured loans come at a higher cost in terms of interest rates. Your lender can also choose to buy your assets when you file for bankruptcy to recover their owed money.

Despite the few drawbacks, a Promissory Note is one of the most advantageous forms of borrowing for your business.