PIK Interest

PIK Interest, also known as a Payment in Kind, is an option to pay interest on preferred securities or debt instruments in kind instead of cash. PIK interest is also referred to as dividend payments to investors of securities or equity in kind instead of money. The Payment in Kind option is attractive to companies that do not wish to pay cash during the initial or growth phase of business.

• PIK interest is also known as a Payment in Kind. It is an option to reimburse interest on preferred securities or debt instruments in kind rather than cash. Moreover, it is also called dividend payments to investors of securities or equity in kind instead of money. 
• It attracts companies who want to avert paying cash at the time of the initial or growth business phase.
• True PIK, Pay if you can, Holdco PIK, Pay if you like are the types of PIK loans per the circumstances and financial objectives.
• The payment maturity in this kind of loan is 5 years or more.

Below are the various forms of PIK loans according to the situations and financial goals:

1. True PIK -The obligation to pay interest in kind is predefined and compulsory in debt.
2. Pay if you can – In this type of debt, the borrower is supposed to pay interest in cash if certain predefined conditions are met. Still, if the predefined conditions are not fulfilled due to some situations, the borrower needs to pay interest in kind at a higher rate than payment in cash.
3. Holdco PIK – Holdco debts are usually unsecured obligations with a final maturity date. In case of default by the borrower, lenders do not have many options to recover these loans because of their unsecured nature. However, lenders can claim equity of the borrower’s business. These types of debts come behind the other priority debt claims like trade creditors, which means debtors can pay Holdco PIK debt after payment of senior/priority debts.
4. Pay if you like – In this form of PIK debt, the borrower can make Payment of interest by cash or kind or a mix of money and style. This type of debt gives a choice to the borrower that they can make Payment in cash if they have surplus money, or at the same time, if a borrower wants to use this surplus cash to invest in business operation, he can opt for Payment in kind option. The interest rate will change according to their choice of Payment. This option is also known as PIK Toggle.

In this type of loan option, because a company is not paying interest on cash, therefore till maturity, every year, the interest gets added in debt, i.e., in principle. Therefore, more debt means the principal amount grows until the loan matures.

In the below example, M/s Stark Inc has taken PIK Notes of $ 10000 on 01.01.2013. These notes have a 10% PIK interest rate, which will mature at the end of 5 years.

In standard debt instruments each year, these notes will incur interests of $ 1000, which the company has to pay every year.

However, in PIK debt, instead of being required to repay the interest amount, the interest is added to the debt in kind that will increase the debt amount as a result in below example at the end of the first year, i.e., on 31.12.2013, the loan amount will increase to $ 11000, and this will continue to grow till maturity.

• These loans are unsecured; it means no need to give any assets as collateral againstthese loans.
• The Maturity of the Payment in the kind loan is 5 years or more.
• Refinancing of payment in kind loans is not possible except for the initial year of the loan.
• These loans give some rights to lenders, which means the lender has a right to take a certain number of shares/securities in place of the loan at the time of maturity of the loan, or lenders can take Assets of the company if the company is not performing well.

• PIK loans are taken if the company has a liquidity problem but can pay interest. It means it is suitable for companies with a long operating cycle.
• In this option, there is no need to pay interest or dividends in the form of cash.
• PIK loans are usually for five years or more.
• PIK loans are generally unsecured loan; there is no need for collateral.
• Such loans come with a warrant that gives the lenders a right to purchase a set number of securities at a fixed price.
• In this option, a company can invest the cash for other capital expenditures, acquisitions, or growth.

• The interest rate on PIK loans is higher than that of Non-PIK loans.
• Lenders do not get any cash inflow before maturity.
• Since no collateral is required, lenders may face massive losses in case of default of payment.

Despite the high-interest rate, payment in kind debt is always in demand because it is blood for companies with a cash crunch and companies in the growth phase. It gives an option to the borrower not to pay interest on cash immediately, which means they can utilize this cash amount for their business operation. Deferring cash interest payments looks attractive, but it increases the company’s principal payment at the end of maturity.

From the lenders’ point of view, PIK is the most suitable strategy when they believe that they are giving loans to the company, which will grow because lenders will get equity in place of interest. Therefore, they do not require to expend any additional cash. Similarly, if there is a loss to the borrower, then the lender will get assets of the business.

It has been a guide to PIK Interest and its definition. Here we discuss the top 4 types of PIK loans along with calculation examples, advantages, and disadvantages. You can learn more about financing from the following articles –

• Holdco
• Loan Shark
• Letter of Credit (LC) Meaning
• Indenture Meaning