What Is a Payment in Kind Loan?

In most conventional type of loans, borrowers need to make regular payments of principal and interested on a fixed schedule. With a payment in kind loan (PIK), borrowers pay interest on PIK loan in forms other than cash.

Payment in kind loans are attractive to businesses that prefer to not make cash outlays and are used in leveraged buyouts. The payment can be in the form of stock options, stock warrants, or additional securities that allows invests to share in the future success of the company.

How Does a Payment in Kind Loan Work?

PIK loans are usually calculated on a compounding schedule and the interest accrues and is added at the principal balance of the loan or paid by new securities.

This type of financing is suitable for investors that are looking for higher returns and willing to assume the high risk. PIK financing is unsecured, not based on any assets, and subordinated to other senior debts of the company.

Advantages of PIK Loans

PIK loans are attractive to companies that want to avoid making current cash outlays for debt interest such as during a management or during a growth phase of the business. To protect liquid assets, companies pay their liabilities with new liabilities.

Disadvantages of PIK Loans

The downside of a PIK loan is that it is risky (for both the lender and borrower) and expensive. The interest is higher than those of conventional loans that are charged on a compound basis. In the case that there is a default, they tend to lead large losses because they are treated as unsecured credit.

Types of PIK Loans

There are three types of PIK loans:

• True PIK loan: this is the simplest type where interested is paid with the issuance of in-kind securities and warrants. At maturity, the principal amount and the accrued interest must be paid.
• Pay If You Can: with this type, the borrower pays a portion of the PIK interest in cash if payment criteria are met.
• PIK Toggles: the borrower has the choice of whether to make payments in cash or in-kind. The borrower has the option of making or not making the interest payments in cash, as necessary.

How Can Your Business Use PIK Loans?

PIK loans can be used by businesses that are small to medium sized to finance their operations during periods of fast growth. A business can increase their borrowing capacity by using PIK loans.

PIK loans are more flexible than other forms of financing and can be used for capital expenditures, working capital, funding the expansion of marketing and sales.

The Bottom Line

Payment in kind loans are issued by companies that are lacking the cash to pay interest. They are undertaken by investors that do not depend on the routine cash flow of the borrower. Before any company decides to use PIK loans, you need to weigh the benefits of the investment and the cost of obtaining them.