IOUs And Promissory Notes: What To Know Before You Lend Money To A New Business

Posted on: 2 April 2015

A lot of people who start home-based businesses turn to their friends and relatives for a little financial help to get started. Usually, they lack the collateral to go to bank for a loan, so the best they can offer their backers are an "I Owe You" (IOU) or a promissory note as security on the loans. Are IOUs worth the paper they're written on? If you're thinking about lending money to a friend or relative to help with their new business (or any other reason), here's what you should know.

IOUs Are Less Formal Than Promissory Notes

Both IOUs and promissory notes are similar in that they acknowledge a debt from one person to another. They both include the name of the lender, the borrower, and the amount of the debt. The borrower always signs both.

Some IOUs are just handwritten documents and some are more formally crafted. They may or may not be notarized when they are signed. Promissory notes are usually formally typed up, not hand-written, and are usually notarized. In addition, promissory notes are:

  • Signed by the lender as well as the borrower.
  • May provide for repayment of the loan "on demand".
  • Guarantees repayment on or by a specific date.
  • Includes any penalties for failure to repay the loan.
  • Includes any information on interest on the loan,

Another important distinction between an IOU and a promissory note is that promissory notes are actually negotiable currency, because they include specifics about when and how the debt is supposed to be repaid. As such, promissory notes can be sold to debt collectors, unlike IOUs.

Can You Collect On An IOU?

Whether or not you can collect on an IOU depends on a variety of circumstances.

An IOU is legal evidence of a debt, and whether the note is handwritten, typed, notarized or not, it does have evidentiary value in court. In many cases, that could be enough to allow you to collect if the situation were to ever come before a judge.

However, since the IOU doesn't specify a time for repayment, that could cause problems with collection. The borrower could raise a defense against a collection action by alleging that he or she hasn't forgotten the debt and still intends to repay it sometime in the future.

Without any specific penalties attached to the failure to repay the debt by a certain time, such a defense could be accepted. A great deal depends on the specifics of your situation, and the jurisdiction in which you live, should the issue go to court.

Unsecured Debt Is Still Unsecured Debt

The problem with both IOUs and promissory notes are that they are still unsecured debt, unless some collateral (like a house or a car) is pledged against the loan.

You run the risk that someone who owes you money will default on the IOU or the promissory note - and file bankruptcy if necessary to avoid payment if you do succeed in getting a court to order repayment. At that point, you'll have to present your IOU to the bankruptcy trustee to see if collecting any of the old debts is possible.

A promissory note is certainly more valuable and has more legal weight than an IOU, but neither are without merit. Just be cautious; never lend more than you can afford to lose because if the borrower refuses to pay you may have an uphill battle trying to collect. To learn more, contact Philip L. Burnett, Attorney At Law.