Meaning
Debt instruments that lack a fixed maturity date allow the lender to request full repayment at any time. These demand notes provide flexibility for lenders who may need liquidity on short notice, while offering borrowers access to capital without a rigid amortization schedule. They are typically used in closely held companies where the lender and the borrower share a high degree of trust.
The applicability of the instrument ceases when the borrower pays the principal and accrued interest in full.
Liquidity Pressure
Borrowers must maintain a high degree of cash readiness to satisfy a sudden call for funds. Because demand notes can be called without warning, they are often classified as current liabilities on a balance sheet. This classification can negatively affect the current ratio and other measures of short term financial health.
Management must weigh the benefit of cheap capital against the threat of an unexpected withdrawal.
Interest Calculation
Rates on these loans are often variable and tied to a benchmark like the prime rate plus a small margin. Interest on demand notes usually accrues daily and is added to the principal if not paid out periodically. This compounding effect can lead to a substantial debt load if the principal remains unpaid for years.
Clear documentation is required to distinguish these loans from equity contributions during a tax audit.
Operational Constraint
Relying on this form of funding limits the ability of a firm to engage in long term capital projects. A sudden call on demand notes might force a fire sale of assets or an emergency equity round. Most sophisticated lenders use them as bridge financing rather than as a permanent part of the capital stack.
Stable growth usually requires shifting to term debt with predictable repayment dates.
