What is Pay-In-Kind Interest in Mezzanine Debt?

What is Pay-In-Kind Interest in Mezzanine Debt?

Pay-In-Kind interest, whose acronym PIK is most commonly used in mezzanine debt circles, is a periodic form of payment in which the interest payment is not paid in cash but rather by increasing the principal amount of the security in the amount of the interest. Currently there is a wide array of PIK loan structures, but all require payment in full upon maturity of the loan. Any interest accrued during the time period of the loan is active and is added to the principal debt or repaid when the loan reaches maturity. Most loans are for 5 to 7 years and do not require collateral.

The role of Pay-In-Kind in a mezzanine debt structure

In mezzanine debt financing, one of the main advantage is the flexibility it offers in debt structure. The structures are usually chosen based on the specific objectives of the transaction and the existing capital structure in place at the company. Most commonly used debt structures include cash interest, Pay-In-Kind interest, and warrant ownership.

How Pay-In-Kind interest works in a mezzanine deal

To understand how Pay-In-Kind interest works in a mezzanine deal, take a look at the following illustration. Assume a company takes a mezzanine loan for $10 million with a 12% in current cash interest and 2% in PIK interest, with no warrants and with the note due in five years time. After a year’s time the current interest, $1.2 million, is paid in cash as required by the note, while the PIK interest, $200,000, is paid in a security and is added to the principal amount of the note, increasing that amount to $10.2 million. This is compounded till the end of the fifth year, when the lender will receive the PIK interest in cash when the note is paid at maturity. Often companies have the option to pay the PIK interest in cash on a current basis if they prefer to.

Benefits of PIK in mezzanine financing

The highly varied nature of mezzanine debt structures require careful consideration before implementation. Therefore, it is always preferable for companies requiring mezzanine financing, to seek the services of an expert financial advisory firm with previous experience in mezzanine finance and with access to a strong mezzanine lender platform.

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