Promissory Note Guide for Small Business Owners: What You Need to Know

Comprehensive guide to understanding promissory notes for small business financing, with essential information for MWBEs, established businesses seeking expansion, and first-time business owners.

Introduction

A promissory note is a legally binding document that formalizes a loan agreement between a borrower and a lender. For small business owners, particularly minority and women business owners (MWBEs), established businesses seeking expansion capital, and first-time entrepreneurs, understanding promissory notes is crucial when securing financing. This document serves as written evidence of debt and outlines the terms of repayment, including the principal amount, interest rate, payment schedule, and consequences of default. Whether you're obtaining funding from a bank, alternative lender, friend, family member, or investor, a properly structured promissory note protects both parties and creates clarity around the borrowing arrangement.

Key Things to Know

1
Always have an attorney review your promissory note before signing, especially for significant business loans. The small cost of legal review can prevent costly mistakes.
2
Keep detailed records of all payments made against the promissory note, including dates, amounts, and confirmation numbers.
3
Understand the difference between recourse and non-recourse loans in promissory notes. Non-recourse limits the lender to collecting the collateral only, while recourse allows them to pursue other assets if the collateral value is insufficient.
4
If interest rates are variable, make sure the note clearly specifies how and when rates can change, and consider negotiating a cap on how high the rate can go.
5
Be aware that promissory notes can sometimes be sold or transferred to other lenders, which could affect your relationship with the debt holder.
6
For loans between family members or friends, a formal promissory note helps maintain professional boundaries and prevents misunderstandings that could damage personal relationships.
7
Consider including a cure period in your promissory note that gives you time to remedy a missed payment before being considered in default.
8
Understand the tax implications of your promissory note, as interest paid on business loans is generally tax-deductible, but there may be other considerations depending on your situation.

Key Decisions

First-time Small Business Owner

Established Small Business Owner Seeking Expansion Capital

Minority or Women Business Owner (MWBE)

Promissory Note Requirements

Lender's Information

Full legal name, address, and contact information of the individual or entity providing the loan.

Borrower's Information

Full legal name, address, and contact information of the individual or entity receiving the loan. For businesses, include the legal business name, entity type, and EIN.

Customize your Promissory Note Template with DocDraft

PROMISSORY NOTE

Date of Execution: [DATE]

Loan Amount: [AMOUNT IN NUMBERS] ([AMOUNT IN WORDS])

1. PARTIES

Lender: [LENDER NAME], a [ENTITY TYPE] with its principal place of business at [LENDER ADDRESS], [LENDER CITY], [LENDER STATE] [LENDER ZIP CODE], [LENDER PHONE], [LENDER EMAIL] (hereinafter referred to as the "Lender").

Borrower: [BORROWER NAME], a [ENTITY TYPE] with its principal place of business at [BORROWER ADDRESS], [BORROWER CITY], [BORROWER STATE] [BORROWER ZIP CODE], [BORROWER PHONE], [BORROWER EMAIL], [EIN/TAX ID] (hereinafter referred to as the "Borrower").

2. PROMISE TO PAY

FOR VALUE RECEIVED, the Borrower hereby unconditionally promises to pay to the order of the Lender the principal sum of [AMOUNT IN NUMBERS] ([AMOUNT IN WORDS]) (the "Principal Amount"), together with interest accrued on the unpaid Principal Amount at the rate specified herein, in accordance with the terms and conditions set forth in this Promissory Note (the "Note").

3. LOAN TERMS

3.1 Principal Amount

The Principal Amount of this Note is [AMOUNT IN NUMBERS] ([AMOUNT IN WORDS]).

3.2 Interest Rate

Interest shall accrue on the unpaid Principal Amount at a [FIXED/VARIABLE] rate of [INTEREST RATE]% per annum, calculated on the basis of a 365-day year for the actual number of days elapsed.

[IF VARIABLE RATE: The interest rate shall be adjusted [FREQUENCY OF ADJUSTMENT] based on [REFERENCE RATE] plus [MARGIN]%. The Lender shall provide written notice to the Borrower of any change in the interest rate at least [NUMBER] days prior to the effective date of such change.]

3.3 Term

This Note shall commence on [START DATE] (the "Effective Date") and, unless earlier accelerated in accordance with the terms hereof, shall mature and be due and payable in full on [MATURITY DATE] (the "Maturity Date").

3.4 Payment Schedule

The Borrower shall repay the Principal Amount and accrued interest in [NUMBER] [MONTHLY/QUARTERLY/ANNUAL] installments of [PAYMENT AMOUNT] each, commencing on [FIRST PAYMENT DATE] and continuing on the [DAY] day of each [MONTH/QUARTER/YEAR] thereafter until the Maturity Date. The final payment shall include all remaining Principal Amount and accrued and unpaid interest.

Each payment shall be applied first to accrued and unpaid interest, and then to the outstanding Principal Amount.

3.5 Payment Method

All payments shall be made in lawful money of the United States of America and shall be made by [PAYMENT METHOD(S)] to:

[LENDER PAYMENT ADDRESS/ACCOUNT INFORMATION]

or to such other address or account as the Lender may designate in writing to the Borrower from time to time.

3.6 Prepayment

The Borrower may prepay all or any portion of the Principal Amount at any time without penalty or premium. All prepayments shall be applied first to accrued and unpaid interest, and then to the outstanding Principal Amount. Partial prepayments shall not affect the Borrower's obligation to make subsequent scheduled payments until this Note is paid in full.

[ALTERNATIVE: The Borrower may prepay all or any portion of the Principal Amount at any time, subject to a prepayment penalty equal to [PERCENTAGE]% of the amount prepaid if such prepayment occurs within [NUMBER] months of the Effective Date. After such period, prepayment may be made without penalty or premium.]

3.7 Late Payment Provisions

If any payment due under this Note is not received by the Lender within [NUMBER] days after its due date (the "Grace Period"), the Borrower shall pay a late fee equal to [PERCENTAGE]% of the amount of such payment. Such late fee shall be immediately due and payable without demand by the Lender.

Interest on any overdue payment (including any applicable late charges) shall accrue from the date such payment was due (without regard to any applicable Grace Period) until paid at a rate equal to the lesser of (i) the regular interest rate plus [PERCENTAGE]% per annum, or (ii) the maximum rate permitted by applicable law.

4. SECURITY AND COLLATERAL

4.1 Secured/Unsecured Status

This Note is [SECURED/UNSECURED].

[IF SECURED, INCLUDE THE FOLLOWING SECTIONS:]

4.2 Collateral Description

As security for the payment and performance of all obligations under this Note, the Borrower hereby grants to the Lender a continuing security interest in and to the following property (collectively, the "Collateral"):

[DETAILED DESCRIPTION OF COLLATERAL, INCLUDING:

Identification numbers
Locations
Estimated values
Any other identifying information]

The Borrower represents and warrants that it has good and marketable title to the Collateral, free and clear of any liens, claims, or encumbrances other than those disclosed to and accepted by the Lender in writing prior to the execution of this Note.

4.3 Perfection of Security Interest

The Borrower agrees to execute and deliver to the Lender any financing statements, continuation statements, assignments, certificates of title, and other documents and instruments as the Lender may reasonably require to perfect and maintain the Lender's security interest in the Collateral under the Uniform Commercial Code or other applicable law. The Borrower authorizes the Lender to file any such financing or continuation statements without the Borrower's signature.

4.4 Maintenance and Inspection of Collateral

The Borrower shall maintain the Collateral in good condition, reasonable wear and tear excepted, and shall not sell, lease, transfer, or otherwise dispose of the Collateral without the prior written consent of the Lender. The Borrower shall keep the Collateral insured against loss or damage in amounts and with insurers satisfactory to the Lender, with policies naming the Lender as loss payee. The Lender shall have the right to inspect the Collateral at any reasonable time upon reasonable notice to the Borrower.

4.5 Guarantor Information

[IF APPLICABLE:] This Note is guaranteed by [GUARANTOR NAME], residing at [GUARANTOR ADDRESS], [GUARANTOR CITY], [GUARANTOR STATE] [GUARANTOR ZIP CODE], [GUARANTOR PHONE], [GUARANTOR EMAIL] (the "Guarantor"), pursuant to a separate Guaranty Agreement of even date herewith.

5. DEFAULT PROVISIONS

5.1 Events of Default

The occurrence of any of the following events shall constitute an "Event of Default" under this Note:

(a) The Borrower fails to make any payment of principal, interest, or any other amount due under this Note within the Grace Period after the date when due;

(b) The Borrower breaches any representation, warranty, covenant, or agreement contained in this Note or any related security agreement, guaranty, or other loan document;

(c) The Borrower or any Guarantor (i) files a voluntary petition in bankruptcy, (ii) is adjudicated bankrupt or insolvent, (iii) files any petition or answer seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any present or future bankruptcy or insolvency statute, law, or regulation, (iv) seeks or consents to or acquiesces in the appointment of any trustee, receiver, conservator, or liquidator, or (v) makes any general assignment for the benefit of creditors;

(d) A court of competent jurisdiction enters an order, judgment, or decree approving a petition filed against the Borrower or any Guarantor seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any present or future bankruptcy or insolvency statute, law, or regulation, and such order, judgment, or decree remains unvacated and unstayed for a period of sixty (60) days;

(e) Any representation or warranty made by the Borrower or any Guarantor to the Lender in connection with this Note proves to have been false or misleading in any material respect when made;

(f) The Borrower or any Guarantor defaults under any other material obligation for borrowed money;

(g) A material adverse change occurs in the financial condition of the Borrower or any Guarantor;

(h) The Collateral is lost, stolen, or materially damaged, if this Note is secured;

(i) The death, dissolution, or termination of existence of the Borrower or any Guarantor; or

(j) The Borrower fails to maintain and preserve the Collateral as required herein, if this Note is secured.

5.2 Acceleration Clause

Upon the occurrence of an Event of Default, the Lender may, at its option and without notice or demand, declare the entire outstanding Principal Amount, together with all accrued interest and all other amounts payable under this Note, immediately due and payable, and the Borrower shall immediately pay the same to the Lender. The Lender's failure to exercise this option shall not constitute a waiver of the right to exercise the same at any subsequent time.

5.3 Remedies Upon Default

Upon the occurrence of an Event of Default, the Lender shall have and may exercise any or all of the following rights and remedies, concurrently or consecutively, in addition to any other rights or remedies provided by law:

(a) The Lender may exercise any or all remedies available under the Uniform Commercial Code or other applicable law;

(b) The Lender may take possession of the Collateral wherever it may be found, using all reasonable means to do so, and may require the Borrower to assemble the Collateral and make it available to the Lender at a place designated by the Lender that is reasonably convenient to both parties;

(c) The Lender may sell, lease, or otherwise dispose of the Collateral at public or private sale in accordance with the Uniform Commercial Code or other applicable law;

(d) The Lender may proceed by suit or suits at law or in equity to enforce payment of this Note and to foreclose upon the Collateral and to sell the same under judgment or decree of a court of competent jurisdiction; and

(e) The Lender may pursue any other remedy available to it at law or in equity.

The Borrower shall be liable for any deficiency remaining after disposition of the Collateral.

6. LEGAL PROVISIONS

6.1 Governing Law

This Note shall be governed by and construed in accordance with the laws of the State of [STATE], without giving effect to any choice of law or conflict of law provisions. The Borrower consents to the jurisdiction of the courts of the State of [STATE] and agrees that venue shall be proper in [COUNTY] County, or in any other county where the Lender initiates legal action.

6.2 Waiver Provisions

The Borrower and any endorsers, sureties, guarantors, and all others who are, or may become liable for the payment hereof severally: (a) waive presentment for payment, demand, notice of dishonor, protest, and notice of protest of this Note, and all other notices in connection with the delivery, acceptance, performance, default, or enforcement of the payment of this Note; (b) consent to all extensions of time, renewals, postponements of time of payment of this Note or other modifications hereof from time to time prior to or after the maturity date hereof, whether by acceleration or in due course, without notice, consent, or consideration to any of the foregoing; (c) agree to any substitution, exchange, addition, or release of any of the Collateral or any other party or person primarily or secondarily liable hereon; and (d) waive all rights of set-off and rights to interpose any defense, counterclaim, or offset of any nature and description in any action or proceeding arising on, out of, under, or by reason of this Note.

The Lender's failure to exercise any of its rights, remedies, or powers set forth herein or the Lender's acceptance of partial payments or any other indulgence granted to the Borrower shall not constitute a waiver of any such right, remedy, or power or of any Event of Default, nor shall any single or partial exercise of any such right, remedy, or power preclude any other or further exercise thereof or the exercise of any other right, remedy, or power.

6.3 Severability Clause

If any provision of this Note, or any portion thereof, or the application thereof to any person or circumstance shall to any extent be invalid or unenforceable, the remainder of this Note, or the application of such provision to persons or circumstances other than those as to which it is invalid or unenforceable, shall not be affected thereby, and each provision of this Note shall be valid and enforceable to the fullest extent permitted by law. In the event any provision of this Note conflicts with applicable law, such provision shall be deemed modified to comply with applicable law in a manner that most closely reflects the intent of the original provision.

6.4 Amendment Procedures

This Note may not be modified, amended, waived, extended, changed, discharged, or terminated orally or by any act or failure to act on the part of the Borrower or the Lender, but only by an agreement in writing signed by the party against whom enforcement of any modification, amendment, waiver, extension, change, discharge, or termination is sought. Any such modification shall not require the consent of any other person or entity not a party to this Note.

6.5 Attorney Fees Provision

The Borrower agrees to pay all costs of collection when incurred, including reasonable attorneys' fees and expenses, whether or not any legal action is instituted to enforce this Note. Such costs shall include, but not be limited to, any costs incurred by the Lender in connection with any insolvency, bankruptcy, reorganization, arrangement, or other similar proceedings involving the Borrower that in any way affects the exercise by the Lender of its rights and remedies under this Note. If any action or proceeding is brought by the Lender to enforce the terms of this Note, the prevailing party shall be entitled to recover its costs and reasonable attorneys' fees incurred in such action or proceeding, in addition to any other relief to which such party may be entitled.

6.6 Successors and Assigns Clause

This Note shall be binding upon and inure to the benefit of the Borrower and the Lender and their respective heirs, executors, administrators, legal representatives, successors, and assigns. The Lender may assign or transfer this Note or any of its rights hereunder at any time without the consent of the Borrower. The Borrower may not assign or transfer this Note or any of its obligations hereunder without the prior written consent of the Lender, and any attempted assignment without such consent shall be null and void.

6.7 Notice Requirements

All notices, requests, demands, and other communications required or permitted to be given under this Note shall be in writing and shall be deemed to have been duly given if delivered personally, sent by nationally recognized overnight courier, or mailed by registered or certified mail, return receipt requested, postage prepaid, to the parties at their respective addresses set forth in Section 1 of this Note, or to such other address as either party may designate by written notice to the other. All such notices, requests, demands, and other communications shall be deemed to have been received: (i) if delivered personally, on the date of delivery; (ii) if sent by nationally recognized overnight courier, on the next business day after deposit with the courier service; or (iii) if mailed as provided above, on the third business day after the mailing thereof.

7. SPECIAL PROVISIONS

7.1 Loan Purpose Statement

The Borrower represents and warrants that the proceeds of this Note shall be used solely for [DESCRIBE PURPOSE OF LOAN], and for no other purpose without the prior written consent of the Lender. The Borrower acknowledges that the Lender is relying on this representation in making this loan.

7.2 Financial Covenants

[IF APPLICABLE:] During the term of this Note, the Borrower shall:

(a) Maintain a minimum cash balance of [AMOUNT] at all times;

(b) Maintain a debt-to-equity ratio not exceeding [RATIO];

(d) Provide to the Lender, within [NUMBER] days after the end of each [PERIOD], financial statements including a balance sheet, income statement, and cash flow statement for such period;

(e) Provide to the Lender, within [NUMBER] days after the end of each fiscal year, annual financial statements [AUDITED/REVIEWED/COMPILED] by a certified public accountant acceptable to the Lender;

(f) Permit the Lender or its representatives to inspect the Borrower's books and records at any reasonable time upon reasonable notice; and

(g) Promptly notify the Lender of any material adverse change in the Borrower's financial condition or operations.

7.3 Conversion Rights

[IF APPLICABLE:] At any time [BEFORE/AFTER/ON] [CONVERSION DATE/EVENT], the Lender shall have the option, in its sole discretion, to convert all or any portion of the outstanding Principal Amount and accrued but unpaid interest under this Note into [TYPE OF EQUITY] of the Borrower at a conversion price of [CONVERSION PRICE] per [SHARE/UNIT], subject to adjustment as provided herein.

To exercise this conversion option, the Lender shall deliver to the Borrower a written notice of conversion specifying the amount to be converted and the date of conversion, which shall be at least [NUMBER] days after the date of such notice. Upon receipt of such notice, the Borrower shall issue to the Lender the appropriate number of [SHARES/UNITS] and, if the entire outstanding balance is not being converted, a new promissory note on the same terms as this Note for the unconverted balance.

In the event of any stock split, stock dividend, recapitalization, or similar event affecting the Borrower's equity securities, the conversion price shall be proportionately adjusted.

7.4 Subordination Terms

[IF APPLICABLE:] This Note and the indebtedness evidenced hereby are subordinate in right of payment to the prior payment in full of all of the Borrower's Senior Indebtedness. "Senior Indebtedness" means all indebtedness of the Borrower for borrowed money, whether outstanding on the date of execution of this Note or thereafter created, incurred, or assumed, unless such indebtedness expressly provides that it is not senior in right of payment to this Note.

The Borrower shall not make, and the Lender shall not accept, any payment under this Note if, at the time of such payment, the Borrower is in default in the payment of any Senior Indebtedness or if any event of default exists with respect to any Senior Indebtedness. If the Lender receives any payment that it is not entitled to receive under this subordination provision, it shall hold such payment in trust for the holders of Senior Indebtedness and shall promptly pay over such payment to such holders.

8. DOCUMENT FORMALITIES

8.1 Date of Execution

This Note is executed and delivered on the date first written above.

8.2 Witness Requirements

[IF APPLICABLE:] This Note must be signed in the presence of [NUMBER] witnesses, who shall also sign this Note to attest to the Borrower's signature.

8.3 Notarization Requirements

[IF APPLICABLE:] This Note must be acknowledged before a notary public or other officer authorized to take acknowledgments.

9. ENTIRE AGREEMENT

This Note constitutes the entire agreement between the Borrower and the Lender with respect to the subject matter hereof and supersedes all prior negotiations, understandings, and agreements between such parties, whether oral or written.

IN WITNESS WHEREOF, the Borrower has executed this Promissory Note as of the date first written above.

BORROWER:

[BORROWER NAME]

By: ________________________________ Name: [AUTHORIZED SIGNATORY NAME] Title: [TITLE]

[IF APPLICABLE:] GUARANTOR:

[GUARANTOR NAME]

WITNESSES:

Name: [WITNESS 1 NAME] Address: [WITNESS 1 ADDRESS]
Name: [WITNESS 2 NAME] Address: [WITNESS 2 ADDRESS]

[IF APPLICABLE:] NOTARY ACKNOWLEDGMENT:

STATE OF ________________ ) ) ss. COUNTY OF ______________ )

On this ____ day of ____________, [YEAR], before me personally appeared [BORROWER NAME/AUTHORIZED SIGNATORY], [IF ENTITY: the [TITLE] of [BORROWER ENTITY NAME]], known to me (or satisfactorily proven) to be the person whose name is subscribed to the within instrument, and acknowledged that [he/she] executed the same for the purposes therein contained.

IN WITNESS WHEREOF, I hereunto set my hand and official seal.

Notary Public My Commission Expires: ___________

Frequently Asked Questions

A promissory note is a written promise to repay a specific sum of money to a lender under defined terms. As a business owner, you need one because it: 1) Formalizes the loan agreement, 2) Clearly documents the amount borrowed, interest rate, and repayment schedule, 3) Provides legal protection for both borrower and lender, 4) May be required by financial institutions or investors, and 5) Creates accountability and structure for repayment. Without a proper promissory note, misunderstandings can arise about loan terms, potentially damaging business relationships and creating legal complications.

A comprehensive promissory note should include: 1) Names and contact information of all parties involved, 2) The principal amount being borrowed, 3) Interest rate and how it's calculated (simple or compound), 4) Repayment terms (payment amounts, frequency, and due dates), 5) Maturity date (when the loan must be fully repaid), 6) Any collateral securing the loan, 7) Default provisions and consequences, 8) Prepayment options or penalties, 9) Signatures of all parties, and 10) Date of execution. For business loans, you may also want to include covenants regarding business operations or financial reporting requirements.

As an MWBE, consider these specific aspects when dealing with promissory notes: 1) Some MWBE loan programs offer more favorable terms, so ensure these are accurately reflected in your note, 2) If using an MWBE-specific lender or program, the note may contain special provisions related to certification maintenance, 3) Document any preferential interest rates or terms you've negotiated based on your MWBE status, 4) Consider including language that addresses what happens if your MWBE certification status changes, and 5) Be aware that some MWBE financing programs may have additional reporting requirements that should be referenced in the note. Always consult with an attorney familiar with MWBE financing to review your promissory note.

Secured promissory notes are backed by collateral (business assets, equipment, real estate, etc.) that the lender can claim if you default. Unsecured notes have no collateral requirement. The better option depends on your situation: Secured notes typically offer lower interest rates and better terms because they're less risky for lenders, but you risk losing the pledged assets if you default. Unsecured notes don't put specific assets at risk but generally come with higher interest rates and may be harder to obtain, especially for new businesses with limited credit history. Consider your business's asset position, risk tolerance, and the loan terms when deciding. Established businesses with valuable assets might benefit from secured notes, while businesses without significant assets may need to use unsecured options.

Defaulting on a promissory note can have serious consequences: 1) The entire loan balance may become immediately due (acceleration clause), 2) Late fees and penalty interest rates may be applied, 3) The lender can pursue legal action to collect the debt, 4) If the note is secured, the lender can seize the collateral, 5) Your business and personal credit scores may be severely damaged, 6) The lender might obtain a judgment allowing them to garnish business accounts or place liens on property, 7) For personal guarantees, your personal assets could be at risk, and 8) Future financing options may be limited or more expensive. To avoid these outcomes, communicate proactively with your lender if you anticipate payment difficulties, as many lenders prefer to negotiate modified terms rather than pursue default remedies.

Personal guarantees on business promissory notes require careful consideration. When you personally guarantee a business loan, you become liable for repayment if your business cannot pay. For first-time business owners, personal guarantees are often unavoidable as lenders want additional security. For established businesses seeking expansion capital, your negotiating power depends on your business's financial strength and credit history. Consider: 1) Your business's ability to repay the loan from cash flow, 2) Your personal financial situation and risk tolerance, 3) Whether you can negotiate a limited personal guarantee (capped at a certain amount or percentage), 4) The possibility of multiple owners each providing limited guarantees, and 5) Whether the loan terms justify the personal risk. Consult with a financial advisor and attorney before signing any personal guarantee.

To negotiate better promissory note terms: 1) Improve your business credit score and financial statements before applying, 2) Shop around with multiple lenders to compare offers, 3) Highlight your business strengths, stable cash flow, and growth potential, 4) Consider offering collateral to secure lower interest rates, 5) Negotiate the interest rate, repayment schedule, and prepayment penalties, 6) Ask for an interest-only period at the beginning of the loan term, 7) Request a longer maturity date to reduce monthly payment amounts, 8) Negotiate caps on variable interest rates, 9) Limit or eliminate personal guarantees if possible, and 10) Work with a financial advisor or attorney who specializes in business financing. MWBEs should also inquire about special programs designed for their businesses that may offer preferential terms.

While related, promissory notes and loan agreements serve different purposes: A promissory note is a shorter document that primarily functions as evidence of debt and a promise to repay. It focuses on the essential terms: amount borrowed, interest rate, payment schedule, and maturity date. A loan agreement is more comprehensive and details the broader relationship between borrower and lender, including representations and warranties, covenants (ongoing obligations), conditions for disbursement, reporting requirements, and detailed default provisions. For simple loans between individuals or small amounts, a promissory note may be sufficient. For complex business financing, you'll likely need both documents—the loan agreement governing the overall relationship and the promissory note serving as the actual debt instrument. Many small business loans use both documents together.