A "payment-in-kind" (PIK) note (or loan) is a way for companies to borrow money. When issuing a bond, a company typically borrows a fixed amount of money, for a fixed period of time, and pays a fixed amount of interest every year. With a PIK note, rather than pay interest each year, the interest is rolled up (capitalised) and added to the principal (hence the name, payment in kind you are being asked to forgo annual interest payments in exchange for a higher overall payment at maturity).
Clearly, PIK loans are riskier than traditional debt (in the jargon, they are a form of "mezzanine debt"), because the lender receives no cash back until the end of the loan period.They are also usually unsecured, and low in the pecking order in terms of repayment if the company goes bust. As a result, they tend to offer high interest rates.
There are also usually high early-repayment penalties (because lenders want to gain the compound interest from the loan, rather than see it repaid early). They are used by companies with high growth potential that would rather use their free cash for expansion and investment. The idea is that the high growth will be sufficient to repay the hefty interest bill at the end of the period. One high-profile example of a deal involving PIK notes going wrong is UK budget fashion chain Peacocks, which went into administration in 2012 (before being bought by Edinburgh Woollen Mill).
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
In 2005, a £404m management buyout of the company was part-funded by £110m in PIK notes, at an annual interest rate of 17.2%. Following the financial crisis, Peacocks was unable to refinance the deal. By 2010, the payment due had reached £301m, and by the time the company went into administration, the PIK liability was thought to be around £400m.
-
SIPP holders to get cash warnings and be offered default fundsNews Providers will be required to offer investors a default fund and must warn customers of the inflationary risk of cash savings the regulator has said. What the new rules mean for your retirement pot?
-
Zoopla: Asking price discounts hit a five-year high – is now the time to buy a property?
News Zoopla’s October House Price Index shows sellers are accepting discounts of 5.5% on average to secure a sale – we reveal where homeowners are taking the biggest asking price cuts
