Legal & IP
Definition
A promissory note is a written, legally binding promise by one party (the maker) to pay a specific sum to another party (the payee) at a specified time or on demand. It is the basic legal instrument underlying most loans — from personal loans between individuals to commercial bank financing and convertible debt in startup fundraising.
A valid promissory note contains: the principal amount; interest rate (or statement that no interest is charged); repayment schedule or demand terms; maturity date; and signatures of the maker. Notes can be secured (backed by collateral — property, equipment, stock) or unsecured. In startup financing, convertible notes are promissory notes with a conversion feature: if the company raises a qualifying financing round before maturity, the debt converts to equity at a discount (typically 15–25%) or at a valuation cap, whichever produces a lower conversion price. Promissory notes are negotiable instruments — they can be transferred (assigned) to third parties. The holder of a note is entitled to payment; in default, they can sue on the note directly. For related-party loans (family, friends), a documented promissory note establishes the loan as debt rather than a gift — avoiding gift tax complications and IRS reclassification issues. Many states require promissory notes to be in writing to be enforceable under the Statute of Frauds.
Whether you are lending money to a business, taking a convertible note investment, or structuring a seller-financed deal, the terms of the promissory note determine your rights, remedies, and risk. An attorney can draft a note that protects the lender's position, structure convertible note terms appropriate for the deal, and ensure the instrument is properly executed and enforceable.