What are Unsecured Short-Term Notes?

Unsecured short-term notes are debt securities issued by entities (typically companies) trying to raise money. The companies promise to repay the investors their principal (the amount of money the investors gives to the companies) plus a return at a specific interest rate on a specific date (usually nine months after issuance). Basically, investors are loaning the companies money and the companies are promising to pay back the loan with interest.

Unsecured short-term notes are often issued by start-ups with little or no credit history and are not listed on any stock exchange. These securities are very risky because if the company goes bankrupt, noteholders will become a general creditor (along with other creditors such as land-lords, utilities, etc.) for assets of the company. Usually, there are not enough assets left over when a company goes bankrupt to repay the noteholders in full. Thus, investors should carefully examine a company's financials before investing to insure that there is sufficient cash flow from operations to repay noteholders at the later specified date.

Many companies will try to attract investors by claiming that they have invented a revolutionary new product or made a breakthrough of some sort. Often, these claims are grossly exaggerated, or downright false. Investors should carefully examine whether the claims are substantiated before investing. Typically, the grander the claims, the more likely it is that they are false.

Companies might also attract investors by stating that the notes are "insured" or "guaranteed." Do not believe these claims. The guarantees are often issued by foreign companies that do not have the capital to repay noteholders in the event of bankruptcy. Even if the guarantees are offered by a well-known insurance company that is authorized to do business in the United States, remember the company could also be lying about the insurance company that is guaranteeing the notes. Ask to see proof of the guarantee and ask if there is a way to verify the information with the insurance company.

When the note matures, companies often ask investors to roll over the principal amount of the note. It is not always a bad decision to roll over a note, but it is important to reassess the investment before rolling it over. Think of it as an entirely new investment decision and ask the same questions. Are the financials in tact? Does the company have a positive cash flow? Are the companies’ claims valid and verifiable, or does it sound too far-fetched? The longer the money stays with the company, the higher the risk that the company might not be able to pay back the money.

Regardless of what a company claims, unsecured short term notes are not "safe" investments. It carries many risks and should be carefully evaluated before investing.