Promissory Notes

Promissory Notes for Small Businesses and Sample Form

One of the biggest challenges that you may have as a small business owner is probably shortage of cash. You want to expand the business, have to pay your suppliers while collecting accounts receivable or cover unexpected emergency expenses.

You can apply for a loan from banks or other financial institution, but occasionally, you may have to borrow money from family members or friends due to its urgency. Either way, you will probably sign a promissory note to assure the lender that you will repay under certain terms.

What do you need to know before you sign a promissory note for your business?

1. Repayment Schedule

- Installment payments with interest: You make installment payments on a regular basis, usually monthly, for months or years. Each payment is applied to interest and principal. As the money you owe declines, the amount for the principal becomes bigger while the amount for the interest becomes smaller with amortization. When you make your final installment payment, your debt is fully paid.

- Installment payments with no interest: It’s the same with the above in the sense that you make installment payments over fixed time. But the whole amount of each payment goes to the principal because there is no interest. This kind of repayment schedule is sometimes selected when you borrow money from your close family members or friends. When you make your final installment payment, your debt is fully paid.

- Installment payments with balloon payment: You make regular payments, usually on a monthly basis, of relatively smaller amount. At the end of the term, you make one large payment (balloon payment) to pay off your debt. This type of repayment schedule can be useful when you have limited amount to repay for the time being, but expect to receive a large amount of fund later.

- Single payment on demand: You repay the loan all at once at the end of the term instead making payments on a regular basis. When you take a loan from your family members or close friends, this kind of repayment schedule is often chosen.

2. Interest Rate
Usury laws regulate the interest rate a lender can charge. It’s usually ranged between 10% and 20%. If your lender wants to charge more than 10%, look into your state law regarding usury. If it goes over the limit, the lender won’t be able to collect the excess amount in the court.

3. Prepayment
Check if you’re allowed to pay some of the principal before the end of the term. Most promissory note forms let the lender pay some principal earlier or pay off the loan before its due date without penalty.

4. Personal Guarantee
When your business is incorporated and you sign a promissory note on behalf of the corporation or the LLC, you are not personally liable for the debt. But banks or other financial institution may require you to personally guarantee the loan.