Most high-dollar-value business loans involve the use of a promissory note. Common financing transactions involving use of promissory notes include bank financing of expensive industrial equipment and inventory. Businesses may also use promissory notes if they finance their customers' purchases. A promissory note provides many advantages whether the business is acting as a lender or borrower.
Definition of Promissory Note
A promissory is a special type of contract in which the borrower -- called the maker -- makes an unconditional promise to pay the lender or a subsequent holder of the note the principal of the loan, with or without interest, by a certain date or upon demand of the lender or a subsequent holder of the note.
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Advantages to Business as Borrower
A promissory note offers two primary advantages to the business borrower. First, a promissory note is in writing. Not all loans are legally required to be in writing. Since all terms, conditions and provisions of the promissory note are in writing, there will be no doubt about the obligations a borrower assumes by making a promissory note. Second, the promissory note must be signed by the borrower. The signature requirement provides another layer of protection for the borrower against fraudulent loans or fraudulent alterations to the loan agreement.
Advantages to Business as Lender
A promissory note offers some distinct advantages for a lender as well. Lenders benefit from a written document that clearly outlines the rights and obligations of both parties. If drafted correctly, the promissory note is easily transferred or sold to a third party. For example, a small business that provides financing for its customers' purchases may be able to sell the loans to a third party. The business avoids the risk of default and is paid more quickly.
Advantages to Third Parties
A promissory note provides advantages to a third party that meets the qualifications of a holder in due course under the Uniform Commercial Code. Basically, a holder in due course is a person or entity that is in possession of the promissory note, gave something of value for it and has no reasonable suspicion to believe that another person has a claim to the promissory note or that a payment on it has been refused. A holder in due course is not subject to most of the defenses the borrower has for non-payment of the debt. These advantages make it easier for a small business to sell its promissory notes.