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For small business owners, a promissory note can be beneficial in terms of financing. They can offer small businesses a way to obtain funding in cases when they’re ineligible for taking out traditional loans. However, before using promissory notes, there are essential considerations to take to ensure you make the right financial decision for your business. Perhaps, it’s critical to know and understand what they are, how they work, and how they can benefit your situation.
Therefore, if you plan to use promissory notes for your small business, here’s everything you need to know about these written agreements.
What Is A Promissory Note?
Essentially, a promissory note refers to a written agreement stating the intention of one party to borrow money from another party and promises to pay within a specific date or time. In order to be legally binding and enforceable, it has to be signed by both parties involved.
A promissory note can be helpful to both lenders and borrowers because it lays out the terms and conditions of the loan. These can include the amount to be borrowed, the interest rate, payment schedule, and other related details.
However, it’s important to know that the laws surrounding the creation and use of promissory notes differ from one state to another. So, if you’re borrowing money for your business, it’s best to seek advice from legal professionals about using a promissory note Florida before deciding to do so. That way, you’ll know how to use this document to your business’ advantage.
What Are The Different Types Of Promissory Notes?
There are various types of promissory notes used in several situations. But the following are the two common types of promissory notes used by small business owners:
- Commercial Promissory Note: It’s a formal written document issued by banks and credit unions when lending money to their borrowers. Typically, lenders use a commercial promissory note for individuals or business owners who take out business loans.
- Informal Promissory Note: It’s a written document entered into for a loan between friends and family members. For example, if you’re a small business owner who borrows money from a family member, using a promissory note can help clarify that the borrowed money is a loan and not a document that gives the lender a right in the business.
What Are The Different Parts Of A Promissory Note?
As a small business owner, it’s essential to familiarize yourself with the different parts of a promissory note. Doing so can help you understand your financial obligations better to avoid non-payment and other issues along the way. The following are the various parts of a legally-binding promissory note:
- Principal Debt: It’s the total amount the borrower agrees to lend from the lender, which should also be paid back within a specific period.
- Issuance Date: It’s the time and date when the promissory note is issued and signed by the parties involved.
- Date of Maturity: It contains the final date when the borrower should pay the entire loan back to the lender.
- Interest Rate: It’s the amount of interest that the borrower agrees to pay the lender for letting them borrow a certain amount of money. It can be charged at a fixed or variable rate that changes over time.
- Repayment Schedule: It indicates the schedule as to when the borrower should pay the loan. The borrower can pay in installments or lump sums at the loan’s maturity date, depending on the agreement.
- Repayment Amount: It’s the amount that needs to be repaid, which includes a part of the principal debt and the interest rate.
- Collateral: It includes any item or possession that can be used as collateral if the lender fails to pay the loan.
- Signatures: Both parties involved should sign the promissory note to be valid and legally binding.
What Are The Things To Consider When Using A Promissory Note?
Since promissory notes are used for business financing, it’s essential to use them properly to avoid problems along the way. When these written documents aren’t taken seriously, mistakes happen, leading to additional debt expenses and litigations. That said, to make sure you’re using a promissory note in the right way, below are some things to consider from the get-go:
- Be aware of the common mistakes in dealing with promissory notes as a small business owner. These can include not ensuring you have the sufficient cash flow to make on-time repayments, failing to include all the necessary terms of the written agreement, and other similar situations.
- Perform financial due diligence to comply with the terms and conditions of the promissory note and avoid problems in the long run.
- Review the terms and conditions of the promissory note carefully before signing it. This is because some promissory note templates may not include essential provisions
- When carrying out the agreement, make sure to keep copies of your records.
- Check the state law that governs your promissory note. For example, the most common limitations are imposed upon secured loans and interest rates. So, if you’re executing a promissory note with parties from multiple states, be sure to specify in the agreement which state law governs the note.
- Don’t hesitate to modify the promissory note when the need arises. As long as both parties agree, you can change a certain provision in the agreement. For example, if you can’t pay the whole loan amount within a short time, you can ask for an extended payment schedule in exchange for a higher interest rate.
What Happens When There Is Non-Payment Or Late Payment Of The Promissory Note?
Using promissory notes as a small business owner may not be easy. Aside from the steps to ensure the proper execution of this written agreement, you also need to consider what happens in case of non-payment or late payments. Typically, some common consequences can include:
- Payment of additional charges or fees for non-payment or late payment of loan
- Filing a lawsuit by the lender against the borrower to recover the outstanding balance
- Sending of the debt to a collection agency
- Using a debt settlement agreement in which the lender changes the amount owed or the payment schedule
As a business owner, you have every right to use a promissory note to obtain financing. However, dealing with this financial instrument is never easy, especially if you have no idea what it is all about. Therefore, keep this guide in mind if you plan to use a note for your business finances. That way, you can successfully make the most out of your promissory note while growing your business.