What it means
A note is a document in which a borrower promises to pay a set amount, with interest, by an agreed date or on an agreed schedule. A secured note adds a pledge of assets such as equipment, inventory, receivables or property.
The security agreement describes what is pledged and what the lender can do if payment stops. Secured notes are common in private lending.
A company may issue notes to a bank, a group of investors or even its own owners, and use the money for expansion or working capital. The note spells out the interest rate, the due date and the borrower's obligations, such as keeping the collateral insured.
To protect its claim, the lender normally files a public notice of its security interest. In the United States this is usually done through a filing known as a UCC-1 statement.
The filing warns other lenders that the asset is already pledged and sets the order in which claims are paid. A secured note usually carries a lower interest rate than an unsecured note from the same borrower, because the lender has a way to recover its money.
It can also be easier to obtain for a business with limited credit history. The trade-off is that the borrower may lose the pledged assets if it cannot pay.
Accountants record the note as a liability and disclose the assets pledged. Anyone reading a balance sheet should check the notes to the accounts to see which assets are pledged and how much borrowing capacity is left.
Priority matters when there are several lenders. If more than one note is secured on the same asset, the order in which they filed usually decides who is paid first.
A later lender may therefore ask the first lender to agree to share or step back.
In practice
Real-world examples.
Example
A landscaping business borrows $80,000 from a local bank using a secured note backed by its trucks and mowers. The bank files its security interest and lends at a lower rate than an unsecured loan. If the business cannot pay, the bank can repossess the vehicles.
Example
A founder lends her start-up $100,000 under a secured note, with the company's inventory as collateral. The note gives her priority over later unsecured lenders. It also gives the company a clear repayment schedule.
Example
A seller of a small business agrees to be paid part of the price over three years. The buyer signs a $200,000 secured note with the business assets as collateral. If the buyer stops paying, the seller can take back the assets.
Formula
Calculation
Simple interest = principal x annual rate x years
A company issues a $50,000 secured note at 8% interest for two years, secured on delivery vehicles, with interest paid but no principal repaid until the end. The interest per year is $50,000 x 0.08 = $4,000. Over two years, total interest is $4,000 x 2 = $8,000, so the company repays $50,000 + $8,000 = $58,000 in all.Case study
Seen in the real world.
Harbor Light Candles is a fictional company that needed $120,000 to buy a new production line. A private lender offered a secured note at 9% with the production line as collateral, compared with a quote of 14% unsecured.
The owner, Nadia, compared the yearly cost of $10,800 at 9% with $16,800 at 14% and chose the secured note. This is an illustrative story, but it demonstrates a common choice. She understood that the lender could take the equipment on default, so she built a cash buffer to protect against a slow sales season.
Nadia also asked her accountant to record the note correctly, with the first-year principal shown as a current liability. She noted the pledged production line in her accounts so that anyone reading them would know it was not free of claims.
Watch out
Common mistakes.
- Assuming a note is secured just because the lender is large. Security exists only if the documents pledge specific assets and the claim is properly recorded.
- Forgetting the filing. A lender that does not register its interest can lose priority to other creditors.
- Pledging an asset that is already pledged. This can breach existing loan agreements.
Questions
People also ask.
What is the difference between a secured note and a bond?
A note is usually a shorter, simpler loan agreement, while a bond is typically a larger debt security sold to many investors.
What happens if a borrower defaults on a secured note?
The lender can enforce its claim by taking and selling the collateral, following the process in the documents and the law.
Does a secured note affect my balance sheet?
Yes, the note appears as a liability, and the pledged assets are normally disclosed in the notes to the accounts.
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