3 min read
What is a promissory note?
When you’re looking for ways to raise funding for your business, it’s helpful to have a few finance options to drive operations. A promissory note allows individuals, groups, and small businesses to get access to funding by borrowing from a lender other than a bank. This can be a suitable alternative if you are not eligible for other sources of capital, such as bank loans. So, what is a promissory note, what are the different types, and what do they contain?
Learn all about this financial instrument with our guide. We explore everything you need to know, including the promissory note definition, what it's used for, and what to include in one.
Promissory note definition
A promissory note in the UK is a legally binding document that upholds an agreement between a lender and a borrower. The note is written by the note’s issuer, promising to pay the note’s payee on a particular date or on demand. The individual or entity that issues the note is the borrower, and the holder of the note is the lender. A promissory note is a debt instrument. What differentiates this financial resource from other types of financing is that a lender doesn’t have to be a bank. They could be an individual, financial institution, or public/private group that lends a borrower money with the expectation that it will be repaid by a specific date.
In addition, once the money is loaned to you, the lender has no say in how you choose to spend it, meaning you can inject cash into any area of your business, manage funds without any external influence and have full control of profit. A common way for a lender to formalise a loan is by creating a promissory note that highlights specific terms and conditions. A promissory note template should typically contain terms pertaining to the principal amount, date and place of payment, as well as rate of interest, maturity date, and the signature of the issuer.
Different types of promissory notes
There are different types of promissory notes. In fact, you may have signed one before, especially if you’ve taken out a particular type of loan. A promissory note in the UK is commonly used for the following loan agreements:
Student loans, to finance education or pay for tuition expenses
Mortgages, for a down payment on a house
Car loans to acquire a car and pay the borrower back in monthly instalments
Business loans for funding a start-up or small business
Personal loans between family and friends
How can a promissory note work for a small business?
You can source capital for your company in the form of a business loan. The seemingly simple framework of a promissory note is advantageous. For example, let’s say your start-up was low on funds as you were growing your operations. The terms and conditions of your promissory note could legislate that you repay the loan once you have made a profit. Used wisely, a promissory note brings convenience and allows for more flexibility whilst you expand as a company and push your business forward.
What information should a promissory note include?
A general promissory note template should contain the following information:
Details of lender and borrower: A promissory note should identify and clearly state the details of both issuer and payee. The written promise can also include details of a guarantor who agrees to pay if the borrower defaults.
Principal amount: The principal amount specifies the amount of money the lender will lend the borrower.
Interest rate: A promissory note will typically include details of interest rates and late fees.
Payment plan: Terms and conditions of a payment plan should be included in the note. It should specify the principal amount, due date and when or how frequently the borrower pays back the money owed. This may be repaid in regular instalments or in one go. The legal note may also state if a loan can be paid off early or in bulk. A promissory note may highlight the consequences or penalties for defaulting on a loan.
For start-ups and small businesses, the simplicity, informalities, and framework of a promissory note in the UK might make it a suitable financing option for your company, allowing you to overcome setbacks due to a lack of funding options and drive your business forward.
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