Just what is a Promissory Note? It’s an informal loan, known as a note payable, a Note, or an IOU. Say, for example, a small business buyer doesn’t have all the capital needed to purchase a business. In this case, the seller may offer seller financing or owner financing. Seller financing doesn’t mean the seller gives the buyer money to purchase the business from them. Instead, seller financing means the seller has worked out an agreement, a Promissory Note. The buyer follows a payment schedule and pays monthly installments to reach company ownership. Often, the buyer makes a down payment and signs a promissory note for the remainder. Sometimes there is also an agreement for a down payment. This document, or P/N, outlines the total number of payments due over time. Additionally, if the buyer defaults on payments, the note contains information about what will happen.
Seller Financing Documents
- Seller Financing Agreement
- Promissory Note
Usually, the Seller Financing Agreement and the Promissory Note are executed when the closing documents are signed, finalizing the sale of the business. This arrangement can be beneficial to both the seller and the buyer. This arrangement can expand the pool of prospective buyers for the seller, making it easier to sell the business. Create a note payable agreement. The result could be a greater profit from the sale of the company. Additionally, a seller might see tax advantages and could make a profit from seller financing.
A promissory note is not the same thing as a contract
A contract describes the terms of a legal agreement. On the other hand, a promissory note does not describe the terms of a legal agreement. It is, however, a legal, binding agreement, even if it’s a handwritten note signed on the back of an envelope or a cocktail napkin – signed by both parties.
If you create your own promissory note, include the following:
- How much will be paid to the seller
- The payment schedule
- How the buyer will make the payments to the seller
In other words, a P/N with a payment schedule is a written promise by the payer to pay the payee a certain amount of money on or by a specific date. Can a Promissory Note be amended? Yes, if the buyer and seller agree to a change, a note can be amended. Typically, the note contains the terms of the debt, such as the principal amount, interest rate, maturity date, date and place of issuance, and the issuer’s (buyer’s) signature.
Buyers can use promissory notes for different circumstances. As previously mentioned, individuals, as well as business entities, issue promissory notes.
Why should you use a promissory note?
When lending a person or business money, you should document the loan and create a promissory note, especially if you are lending a large amount of money. A promissory note is a legal, binding agreement. Having this signed note protects you if you need to bring legal action against the payer.
What should a promissory note include?
- Name of the party that promised to repay the stated debt. (Payer or borrower)
- Lender’s name (Payee or lender)
- Exact date(s) the promise to repay is effective. (Date)
- Amount of the money borrowed. (Amount or principal)
- Interest rate charged if applicable. (Interest Rate)
- A typical arrangement is to have the first payment due on the first day of the month. Although this is a typical arrangement, the payment dates are up to the lender. (Date first payment is due)
- Frequency the buyer will make payments and the amount of each payment. (Payment Details)
- In the case of an amortized loan (a loan paid off in a series of even and equal payments on specified dates), the date the note ends could be the last payment. An agreement could also involve a balloon payment, setting a date on which the entire unpaid balance is due. (Date the promissory note ends)
- The borrower’s and the lender’s signatures are on the agreement. To be legally binding and enforceable, the note requires the signature of each party, payer, and payee. (Signatures)
What happens if a buyer defaults on the IOU?
Depending on what’s defined in the agreement associated with the note payable, if the buyer defaults (doesn’t pay), the seller would be able to get the business back. This right needs to written out in the agreement. However, this may not always be the best plan. For instance, the company might not be performing well. As part of the note terms, the seller should negotiate a personal guarantee from the buyer. Additionally, as part of the terms, the seller should require the buyer to provide periodic financial reports on the performance of the business. A seller needs to protect themselves in the event the buyer defaults.
A potential downside of selling a company on a promissory note is that a buyer could run the acquired business poorly. This scenario could cause the company to lose value. Therefore, the seller would lose part of the overall payout price.
Final Thought
A promissory note will generally be part of the purchasing agreement when exiting a business, and the sale is a seller-financed transaction. Understanding rates, terms, payment period, and what happens if a buyer defaults are all essential matters to agree upon to draft the promissory note properly. The professionals at ExitGuide can assist you. First, let us help you create a business profile to market the business and upload documents for due diligence. Then, let’s get you to the agreement stage.