Promisory Notes

What is a Promissory Note?

Promissory notes are a written promise to pay a specified amount to a specific entity at a specific time or upon demand, with or without interest. Promissory notes are presumed to be securities. For this reason, individuals purchasing or issuing promissory notes need to make sure the transaction complies with securities regulations.

Promissory notes offered to retail investors carry significant risk. When investing, higher returns are accompanied by a proportionate amount of risk. A track record of paying high interest and even repaying principal is not an assurance that you will get your money back if the company fails. Promissory notes are rarely suitable for retirement money, or money borrowed against home equity.

Concerns

Registration Concerns

Most promissory notes are sold with little or no disclosure information. Moreover, the person offering a promissory note may need to be licensed. Prior to making an investment, you should know whether the investment is:

registered under Utah’s Securities law;
exempt from registration under Utah law; or
a federal covered security, notice file in Utah.

In many cases, promoters fail to properly follow securities laws and offer unregistered securities to Utah investors, which is a violation of the law.

Disclosure Concerns

Many promoters fail to provide investors with adequate disclosure documents. Some promoters will mislead or misrepresent the information and risks in their disclosure documents. Omission or misrepresentation of material information in the offer or sale of a security is considered securities fraud. The information should include a clear description of the issuer's business, risks of the business, audited financials, and commissions to be paid to the person soliciting your investment.

Licensing Concerns

A promoter may or may not need to be securities licensed as a broker-dealer or investment adviser. Licensing is required anytime a sales agent or promoter sells a security and receives compensation or renders advice regarding a security for compensation.

Key Questions Before Investing

Most notes are illiquid and cannot be redeemed until maturity. Problems with your investment may be difficult to identify until your principal is to be repaid. At this late date, you may discover that your investment has failed and there is no money to be paid to you. Due to the note not being listed on any exchange, there is rarely any secondary buyer for the notes. If the issuer is having financial difficulties, they will be unwilling to cash out your note.

To help you perform the proper due diligence before investing, you should be provided a private placement memorandum, private offering memorandum, or some other document that fully details information about the investment, including managers, financials, track record, investment strategy, and the risks associated with that strategy. Like a mutual fund’s prospectus, an investment’s disclosure document should be substantial in length (typically 30 to 60 pages).

Before investing you should research the principles of the company and those selling the investment. The first step may be a simple internet search to find any information, and second, contact the Utah Division of Securities to verify. You may search other regulators, such as Utah Division of Real Estate or the Utah Deipartment of Insurance. Greater due diligence may require looking for any court records for criminal or civil matters.

Don’t confuse payment of interest with a successful investment. Often interest is paid from the soliciting of new moneys. The risk/reward principle dictates the higher the return, the greater risk. You should compare the stated interest return to bank Certificate of Deposits and Corporate Bonds. Historically, an exceptional fixed rate of return is 3-5 percent per year (above inflation). An investment boasting a rate of return of 10-20 percent per month is not sustainable or viable. While such returns are suspect, even if they were accurate, they would reflect serious risks. In short, if it’s too good to be true, it probably is.

Promoters will often use words like “guaranteed” or “risk free” implying the investment is backed by real property. They may also claim it is not a security due to this collateralization. If your name is not on the title or asset backing the investment, you will have a difficult time collecting. Even if you do gain title to the property, important questions to explore are can you sell it and is it encumbered through a bank or tax lien?