Promissory Note Valuations - Basic Factors By: Lawrence Tepper Tel: (303) 779-6996 Email Mr. Tepper Website: www.promissorynoteappraisers.com

The Fair Market Value of a promissory note is dependent on three key elements-enforceability, collectability and marketability.

Attorney Training

Most attorneys are trained to draft promissory note loan documents that are enforceable in a court of law. But, that is only providing one-third of the necessary valuation features that the client actually needs. The additional valuation features required are that the note be collectable and marketable. Most attorneys have little experience in structuring the notes for collectability and marketability.

Definition of Value

Generally, promissory note valuation engagements require a determination of the Fair Market Value of the note. Fair Market Value is defined as: "The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts."

No Market Place

The first challenge that the valuation expert must deal with is that there is no recognized market place where private promissory notes are bought and sold. There are stock markets, bond markets, and commodity markets, but there is no private note market. These notes change hands informally, based on one-on-one negotiations, between the parties. In order to obtain a tentative offer or quote from a potential buyer, the seller must first locate the correct person or entity that understands, and is interested in, the specifics of the note being offered and who also has the capital to make a bona fide offer.

Typically, note buyers tend to be specialists, because the individual notes are each specially tailored to a specific business transaction-each note is unique.

As an example, there are farm and ranch note buyers, single family home note buyers, business sale note buyers, and commercial and industrial note buyers. Some note buyers only deal with individual notes, some only with packages of notes, some only with small denomination notes, and some with only large denomination notes. Some only deal in one state, some only in one region, and some deal nationally.

Analysis of Collateral Security

The second challenge that the valuation expert must deal with is the analysis and evaluation the collateral security and the documentation supporting the promissory note. There are numerous documents and information needed. In order to value a promissory note the expert doing the valuation must have as much information relating to the specific transaction that originated the note as possible. Additionally, the valuation expert needs all the available documentation that supports the note's value and relates to its terms, collectability, and enforceability.

Additional Components to Analyze

Being able to analyze the following items and documents are vital to determining the Fair Market Value of a promissory note.

Collateral Security Information:

• Appraisal Report

Title Insurance

Borrower's Credit and Financial Information

• Credit Score
• Work History
• Income Statement
• Balance Sheet

Promissory Note Information

• Copy of the Note
• Copy of the Deed of Trust/Mortgage
• Copy of any Related Documents - Assignment of Rents, etc.
• Copy of the Payment History - Payments Past Due
• Valuation Date-Date of valuation has a huge impact on the conclusion

Other Important Documents

Copies of probate documents, executor and Personal Representative documents, divorce documents, partnership documents, disillusionment documents, Bankruptcy documents, etc.

The Most Important Elements in Determining the Value of a Note

• Loan to value ratio
• Down payment amount-type of down payment-cash or other
• Value of the collateral security
• Position or rank of the lien encumbrance-1st or 2nd position
• Size of the note
• Mortgage's Title Insurance Policy
• Credit history and financial history of the borrower
• Interest rate of the note
• Term/length of the note
• Late payment penalty clause in the note
• Due on Transfer clause
• Default interest rate
• Default collection costs provision
• Holder In Due Course status

Why Are Promissory Notes Appraised?

There are numerous business, taxation, and legal reasons why a promissory note valuation is required. List below are examples:

• Bankruptcy
• Mortgage Fraud
• Marital Dissolution (Divorce)
• Probate & Wills
• Trusts
• Gifts
• IRS Estate Tax Filing 706, 709, 8283
• Estate Planning
• Fractional Valuations
• Estate Settlement Valuation
• Partnership Dissolution
• IRS Taxation issues
• Accounting Matters
• Promissory Note Valuations for a Balance Sheet

Conclusion Determining the fair market value of Promissory Note is as much an art as a science.

Each note has its own unique terminology, collateralization, and history. The investors that comprise the market for these individual notes are a small, fragmented, and specialized group. The various techniques that can use in determining the value of a note are like a mechanic's tools. The one to use depends on the situation and your goal. Just as no mechanic's tool is appropriate for every job, neither is any one valuation technique appropriate for every situation. Each valuation technique has advantages and disadvantages, and most are only useful in a narrow range of circumstances.

It is probably obvious now that the valuation of a promissory note is influenced by many, many facts, documents, and assumptions. Further, it should be clear that the "value" of any note is tied to the valuation definition being used. As an example, a valuation that would satisfy someone receiving a note as a gift might not satisfy the IRS for taxation purposes; the valuation that would satisfy a father loaning his son down payment money probably would not satisfy a third-party professional note investor. Depending upon your specific legal and practical needs, select a valuation expert that has the training and experience to delivery a defendable valuation report.