Payment-in-Kind (PIK)
Payment-in-kind (PIK) is the use of a good or service as payment instead of cash. Payment-in-kind securities are attractive to companies preferring not to make cash outlays and they are often used in leveraged buyouts. Payment-in-kind (PIK) is the use of a good or service as payment or compensation instead of cash. To illustrate how payment-in-kind notes work, imagine a financier offers a struggling company payment-in-kind notes worth $2 million. Payment-in-kind notes give the issuer a chance to delay making dividend payments in cash and return for the delay, the issuing company typically agrees to offer a higher rate of return on the note. The Internal Revenue Service (IRS) refers to payment-in-kind as bartering income and it requires people who receive income through bartering to report it on their income tax returns.
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What Is Payment-in-Kind (PIK)?
Payment-in-kind (PIK) is the use of a good or service as payment instead of cash. Payment-in-kind also refers to a financial instrument that pays interest or dividends to investors of bonds, notes, or preferred stock with additional securities or equity instead of cash. Payment-in-kind securities are attractive to companies preferring not to make cash outlays and they are often used in leveraged buyouts.
Understanding Payment-in-Kind (PIK)
Payment-in-kind securities are a type of mezzanine financing, where they have characteristics indicative of debt and equities. They tend to pay a relatively high rate of interest but are considered risky. Investors who can afford to take above-average risks, such as private equity investors and hedge fund managers, are most likely to invest in payment-in-kind securities.
Payment-in-kind notes give the issuer a chance to delay making dividend payments in cash and return for the delay, the issuing company typically agrees to offer a higher rate of return on the note.
In most cases, PIK notes compromise a fraction of a company's total outstanding debts, and the financier structures these notes so they mature later than the company's other debts. This allows the company to focus on repaying traditional debts or debts tied to cash dividends more quickly, but it adds additional risk to the financier. To cover their risk, most financiers stipulate an early payment penalty to maximize their potential earnings.
The phrase "payment-in-kind" also applies to accepting cash alternatives for work or services. For example, a farmhand who is given "free" room and board instead of receiving an hourly wage in exchange for helping out on the farm is an example of payment-in-kind.
The Internal Revenue Service (IRS) requires people who receive payment-in-kind income through bartering to report it on their income tax return. For example, if a plumber accepts a side of beef in exchange for services, he should report the fair market value of the beef or his usual fee as income on his income tax return.
The Internal Revenue Service (IRS) refers to payment-in-kind as bartering income.
Example of Payment-in-Kind
To illustrate how payment-in-kind notes work, imagine a financier offers a struggling company payment-in-kind notes worth $2 million. The notes have a 10% interest rate and they mature at the end of a ten-year period. Each year, the note incurs $200,000 in interest.
However, instead of being required to repay that amount or any principal payments, the interest is added to the debt in kind, meaning more debt. As a result, by the end of the first year, the company owes $2.2 million and that amount continues to grow until the loan matures, at which time the cash is due.
What Is the Original Meaning of Payment-in-Kind (PIK)?
The phrase "payment-in-kind" also applies to accepting cash alternatives for work or services. For example, a farmhand who is given "free" room and board instead of receiving an hourly wage in exchange for helping out on the farm is an example of payment-in-kind. PIK is derived from the bartering system that was used before the advent of money as a means of exchange.
What Is Payment-in-Kind (PIK) Debt?
Payment-in-kind also refers to a financial instrument that pays interest or dividends to its investors. It's a type of mezzanine financing with characteristics indicative of debt and equities. They tend to pay a relatively high rate of interest but are considered risky. PIK notes give the issuer a chance to delay making dividend payments in cash and return for the delay, the issuing company typically agrees to offer a higher rate of return on the note.
Why Would PIK Debt Be Attractive to Some Firms?
PIK securities are attractive to companies preferring not to make cash outlays. In most cases, PIK notes compromise a fraction of a company's total outstanding debts, and the financier structures these notes so they mature later than the company's other debts. This allows the company to focus on repaying traditional debts or debts tied to cash dividends more quickly, PIK debt is often used in leveraged buyouts.
Related terms:
Barter (or Bartering)
Barter, or bartering, is the act of trading a good or service for another good or service without the use of money. read more
Buyout
A buyout is the acquisition of a controlling interest in a company; it's often used synonymously with the term "acquisition." read more
Cash Bonus
A cash bonus is a lump sum of money typically awarded as in incentive for an employee's superior performance. read more
Constructive Dividend
Constructive dividend is a concept in which distributions to shareholders are not labeled dividends but are still considered taxable dividends by the IRS. read more
Equity : Formula, Calculation, & Examples
Equity typically refers to shareholders' equity, which represents the residual value to shareholders after debts and liabilities have been settled. read more
Hedge Fund
A hedge fund is an actively managed investment pool whose managers may use risky or esoteric investment choices in search of outsized returns. read more
Income
Income is money received in return for working, providing a product or service, or investing capital. A pension or a gift is also income. read more
Mergers and Acquisitions (M&A)
Mergers and acquisitions (M&A) refers to the consolidation of companies or assets through various types of financial transactions. read more
Mezzanine Financing
Mezzanine financing combines debt and equity financing, starting out as debt and allowing the lender to convert to equity if the loan is not paid on time or in full. read more
Nonmonetary Transaction
A nonmonetary transaction occurs when a business or commerce activity concludes without the transfer of money between accounts for parties tied to the transaction. read more