Loan Agreement vs Promissory Note
When you lend or borrow money, the document you choose makes a real difference. Two of the most common options are the Promissory Note and the Loan Agreement. At first glance, they may look similar, but in practice they protect you in very different ways. Choosing the wrong one can create serious problems later. Let’s break it down in simple terms.
What Is a Promissory Note?
A Promissory Note is a short, straightforward written promise from the borrower to the lender. It says:
“I borrowed this amount of money, I will repay it by this date, at this interest rate, and here is what happens if I don’t.”
That’s essentially it.
A Promissory Note usually fits on one or two pages. Both parties sign it, and the loan is documented. Promissory Notes are popular because they are fast, simple, and inexpensive to create. They are best suited for situations where trust is high and speed matters more than detailed control, for example:
- A founder provides short-term or bridge funding to their own startup
- A friend or family member helps with temporary cash flow
- An angel investor issues a small bridge loan
- Funds are needed quickly and the relationship is informal
Two Types of Promissory Notes
Unsecured Promissory Note
An Unsecured Promissory Note is not backed by collateral. The lender relies solely on the borrower’s promise to repay. Because the risk is higher, interest rates are often higher or repayment terms are shorter.
Secured Promissory Note
A Secured Promissory Note is backed by collateral, such as equipment, company shares, intellectual property, or future revenue. If the borrower fails to repay, the lender may enforce against that asset. This structure offers greater protection to the lender and often results in more favorable terms for the borrower.
What Is a Loan Agreement?
A Loan Agreement is a comprehensive, detailed contract. It is much longer than a Promissory Note and can run 20–50 pages or more. Rather than simply confirming repayment, it governs the entire relationship between the lender and the borrower.
A Loan Agreement typically covers:
- Ongoing financial reporting obligations
- Restrictions on taking additional debt
- Rules on dividends, distributions, or major expenses
- Detailed default procedures and cure periods
- Enforcement rights relating to collateral
- Personal guarantees from founders (in some cases)
- Limitations on selling the company or key assets
Banks, venture debt funds, and professional investors almost always use Loan Agreements. They provide clarity, control, and strong legal protection. While they take more time and cost more to negotiate, they significantly reduce uncertainty and make enforcement far more predictable if something goes wrong.
Key Differences Made Simple
Here’s what really matters in practice.
So Which One Should You Use?
Ask yourself:
- How much money is involved?
- How strong is the trust between the parties?
- Do you need ongoing control or reporting?
- Is collateral important?
- Might the loan be transferred later?
- Are you comfortable with simple enforcement if repayment fails?
If the loan is small, fast, informal, and based on trust, a Promissory Note (secured if possible) is often enough.
If the loan is larger, longer-term, or requires real legal protection and control, a Loan Agreement is the safer choice.
Many startups begin with Promissory Notes for early friends-and-family or angel funding, and later move to full Loan Agreements when working with institutional lenders or raising venture debt.