What is a Promissory Note?
A promissory note is a written document that binds one party to pay another through credit. The agreement is considered a debt instrument as it typically contains loan-type features such as the repayment terms, principal amount owed, interest rate, maturity date, date of issuance and both parties' signatures.
While some financial institutions may issue promissory notes, they are primarily used as a means for businesses and individuals to obtain financing from a source other than a traditional bank.
Promissory Note Examples
As a debt instrument, promissory notes can be as simple as an IOU or extremely detailed and complex, depending on the amount and purpose of the loan.
While they may be used as a debt agreement between individuals, promissory notes are typically used by businesses with few financing options that need access short-term financing. In bypassing traditional banks or public capital markets, corporate promissory notes carry higher risks of not being repaid and thus typically carry higher rates of interest. If these notes are to be sold to multiple investors, they may require registration in the states where they are being sold or with the Securities and Exchange Commission (SEC).
Individuals or businesses holding promissory notes may list them as a balance sheet asset, much like an accounts receivable. Individuals or companies issuing a promissory note would report the note as a liability, similar to an accounts payable.
Are Promissory Notes Legally Binding?
Yes, as long as the two parties are qualified to enter into a debt agreement, the note is legally binding whether or not it is witnessed and/or notarized.
More than a century ago, promissory notes could be used in place of checks or cash. But because of fraud and abuse of the system over the years, and because they are negotiable, promissory notes are not usually seen as the equivalent of cash and are not considered legal tender.