Promissory Notes . . .

are written promises to repay money borrowed plus interest. They typically describe the amount borrowed, the interest charged, and the method for repaying the lender.

Promissory notes can be secured or unsecured. If they are secured, property (collateral) is pledged to back up the company’s promise to pay. If the note is not paid on time, the lender can foreclose on the collateral and apply the proceeds to pay down the note. Unless they specify otherwise, promissory notes are assumed to be with recourse. That is, the holder of the note can collect it against the maker directly if it is not paid. If the note specifies, however, its holder can be limited to proceeding only against the collateral that secures the note.

Promissory notes can be, and often are, backed up by personal guarantees of key management members. Guarantees are commonly required by banks and lending institutions that lend to entrepreneurial companies. Promissory notes that are not secured or guaranteed are backed only by the company’s promise to pay. Young companies sometimes issue unsecured notes when they borrow from friends, family, or management.

Professional venture investors often require more sophisticated debt instruments, such as debentures or debt-like instruments such as redeemable preferred stock. When they use notes, they often require management to execute guarantees. See: Angels, Collateral, Debentures, Factoring, Inventory Financing, Nonrecourse Debt, Personal Guarantees, Receivables Financing.