How to Sell a Promissory Note

Promissory notes are valuable financial tools, representing a promise to pay a specific amount on a future date. Individuals or businesses that hold those notes may want to sell them for a number of reasons, including having ready access to the funds named in the note or needing to relieve themselves of that financial obligation.

Selling a promissory note transfers the value and the borrower’s obligation to pay to the other party. In order to sell, it will need to be signed by both parties involved.

Why Sell Promissory Notes?

There are several reasons you might choose to sell a promissory note or transfer a loan agreement. Sometimes, that reason comes up unexpectedly: you might have initially intended to hold onto it long-term but determined, for whatever reason, that it is no longer financially practical or feasible. In other cases, businesses, in particular, might have never intended to hold onto a note for the full life of the loan. This is common in real estate transactions.

Deciding to sell or hold a promissory note is unique to each individual or entity. The main reasons include:

• You need to turn a non-liquid asset – that is, a valuable object or investment – into a liquid one that you can use immediately.
• You have financial obligations that you need to meet short term, and the note will provide the value needed to accomplish that goal.
• You do not want to take on the risk of holding it long-term.
• You do not want to track the records and paperwork related to holding the note over time.
• You have an unexpected financial emergency and need to quickly liquidate funds.
• You have changed the function or structure of your business in a way that makes it impractical to hold onto a note.

Selling a Promissory Note in 10 Steps

Make sure you understand the key factors that can influence the sale due diligence process and outcomes before you move forward. Selling a promissory note is much like transferring a loan agreement.

Step 1 – Assess the Market

Before you decide to sell a promissory note, take the time to carefully assess the market and get a feel for how it’s performing. Ideally, you want to sell it at a time when the market is going well and promissory notes are selling for a high percentage of their original value.

However, if you need to make a sale quickly for your own financial reasons, you may need to sell even when the market is less favorable.

Step 2 – Determine the Note’s Value

You will need to have a good idea of what the specific note is worth. You may want to take it to a specialist to have it evaluated.

In general, the value of a note is defined as the value of the payments left, including interest. An independent expert can let you know what the whole note will likely sell for, giving you a better idea of its full value on the current market.

Step 3 – Gather Documentation

That may not only mean the note itself and proof of its validity but also any other documentation related to the loan or the note. You may want to include things like records of payments on the promissory note, any collateral, and documentation associated with the original borrower’s financial status.

You will need to present this documentation both to potential note buyers, who may use it to get a better idea of whether they want to purchase the note, and to the eventual buyer of the note.

Step 4 – Consider Legal Requirements

First, determine whether the note is eligible for sale. A negotiable promissory note is generally transferrable, which means that you can sell it to another party, and they can collect on the debt laid out in the note.

A non-negotiable note, on the other hand, may not be transferrable, which means you do not have the right to sell it. Furthermore, make sure you have provided all necessary legal documentation and that you are not misleading potential buyers, which could open you up to legal liability in the future.

Step 5 – Identify Potential Buyers

Get a feel for who might be willing to buy the note from you. A private buyer may buy it from you directly. Sometimes, that may mean you ultimately get a larger percentage of the initial value from the transaction.

You may also be able to find a note-buying company. Keep in mind that individual buyers may not have a strong understanding of the market or how to best structure a deal, so you should be sure to do your due diligence before making a sale.

Step 6 – Negotiate Terms and Pricing

Talk to the potential buyer about the terms of the deal. Discuss how much they are willing to pay and under what terms: will they transfer the payment amount immediately? When will payment come due? Determine what you consider reasonable pricing, including how much you might ultimately miss out on as part of the deal and what concessions you might be willing to make.

If you need to make a quick sale to raise capital or deal with a financial emergency, you may be willing to accept less than if you simply want to transfer the promissory note to end your obligations.

Step 7 – Execute the Sale Agreement

You must put together a sale agreement that transfers ownership of the legal document and future payments to the other party. The sale agreement is the legal confirmation of the arrangement between you and the other party.

Once it is complete, the other party is obligated to buy the note at the price you have laid out based on the terms of the agreement.

Step 8 – Complete the Transfer

Transfer the note to the other party. You may need to sign it as well as fill out any other legal closing documents related to the sale.

Once the transfer is completed, the other party has the right to collect on the debt laid out in the note, and you, as the seller, are able to collect payment for the note from the new buyer.

Step 9 – Execute Follow-Up and Documentation

Make sure that you carefully document the terms of the transfer and keep that documentation for your records. If the original borrower does not pay their debts on time, you want to be able to show that you did your part in the transaction.

Furthermore, you want to document the transfer so that you know all your obligations related to the transaction have been completed properly.

Step 10 – Review Tax Implications

According to the IRS, any income generated by the sale is taxable. A promissory note often starts off with an initial loan. Repayment of that loan amount is not taxable income, so if you sell it for less than the initial value of the loan, you may not have any tax obligations.

On the other hand, if you have received any income as a result of the promissory note, from selling it for more than its initial value to collecting income through interest as payments have been made over time, that income may be taxable. Consult with an accountant to get a better idea of the specific tax obligations and ensure that you have paid those taxes in a timely manner.

Selling an Unsecured Promissory Note

A secured promissory note uses collateral to secure the loan. An unsecured promissory note may prove more difficult to collect on or enforce since the borrower does not have specific assets to back that sale. That may mean several things when you’re trying to sell one:

• First, it may mean that there are fewer buyers available. Some buyers may not want to take on an unsecured note and the risks that can accompany it. They may worry that they will not be able to collect on the debt, especially if the borrower has a history of nonpayment or is otherwise failing to keep up with their financial obligations.
• Due to the lower volume of buyers and the potential for higher risk, you may need to sell it at a steeper discount than a secured promissory note. Working closely with your buyers can help you arrive at an agreement that comes closer to fitting your needs.

However, there are certain factors outside your control that can affect the discount rate and whether you will be able to sell:

• Credit ratings: If the borrower has a high credit rating, you may have an easier time selling than if the note buyer has a lower credit rating.
• Interest rates: A high-interest rate may make it easier for you to sell, even one with a higher level of risk, because of the higher potential gain for the new note buyer.
• Default: If the borrower has a history of defaulting on loans or has already defaulted on the note for any reason, you may have a much harder time selling it.

Taking these factors into account before you try to sell an unsecured promissory note can give you a better idea of what to expect and how you can negotiate.

How to Protect Yourself Against Promissory Note Fraud

Before selling, sellers should take several key steps to protect themselves from a promissory note scam:

• Verify the legitimacy of buyers: Shady organizations will claim to offer you funds for a promissory note, often at a reasonable deal, but they may not actually follow through on payment or try to steal the note from you. By doing your research ahead of time, you can ensure that organizations intending to purchase are legitimate and will follow through.
• Conduct thorough due diligence: Do all your research and gather all relevant documentation regarding your promissory note. Do not fail to disclose any information pertinent to the note buyer, which could leave you open to legal implications in the future.
• Use secure payment methods: They ensure that the note buyer cannot simply write a bad check or fail to transfer the funds. They also prevent the buyer from pulling those funds back after the transfer is complete.
• Stay alert for suspicious activity: If you feel uncertain about any activity that occurs during the transaction, consider stopping it and selling to someone else. Red flags may include an offer that seems too good to be true, especially compared to others you may have received, or a note buyer pressuring you to use an insecure payment method.

Valid promissory notes are typically verifiable through a quick check on the SEC’s EDGAR database. While navigating the selling process, it’s crucial to remain vigilant and stay informed about potential risks and fraudulent activities.

Conclusion

Whether prompted by a sudden need for liquidity, a shift in business structure, or an unexpected financial emergency, selling a promissory note can be a strategic move that requires a thoughtful examination of the market, a precise valuation of the note, and strict adherence to legal protocols.

A well-structured approach ensures a smooth transaction that allows individuals and businesses to efficiently manage their financial portfolios and obligations.