PIK Interest: a Worked Example

PIK appears where cash is scarce or deliberately kept for something else: mezzanine finance, notes issued by a holding company above a group's operating debt, private credit loans that take part of their margin in kind, and amendments that switch a struggling borrower from cash interest to PIK for a period. In the United States, a 2026 Federal Reserve Bank of Boston study of business development companies found the share of their loans paying interest in kind rose from about 6% in early 2022 to about 10% in early 2026, and read the rise as pressure on borrowers' cash flows. Those are American figures, not a measure of the three markets this site covers.

The risk sits in what PIK removes. A cash-paying loan tells its lender early when the business runs short, because a payment is missed. A PIK loan stays current through a bad year. The test comes at maturity or refinancing, when the whole compounded sum must be repaid from a sale, new borrowing or the cash that was kept along the way.

The documents vary. Interest may be wholly in kind, or split between a cash margin and a PIK margin. A toggle lets the borrower choose cash or PIK each period, often for a limited number of periods and often at a higher rate when it chooses PIK. How often the interest compounds, quarterly or yearly, is a term of the agreement and changes the balance. In accounts that carry the loan at amortised cost, the PIK interest is charged in the income statement like any other interest and added to the liability, while the cash flow statement shows none paid. EBITDA does not move, so leverage rises only through the debt. How each market taxes interest that accrues but is not paid is a separate question for the borrower's advisers.

A sponsor-backed group of funeral homes, constructed for this page like every figure in it, earns EBITDA of US$30m. Its operating company owes senior lenders US$90m at 8% paid in cash, US$7.2m a year. Its holding company has issued US$30m of notes at 13% PIK, compounding yearly, with everything due in year five. The rates are the example's. EBITDA is held flat to isolate the debt. In US$m:

The senior lenders are paid every quarter and their cash cover does not change. Meanwhile the note has grown by 84% and the group's total leverage has risen by more than three-quarters of a turn with nothing in the business different. To hold leverage at 4.0 times, EBITDA would need to reach 145.3 ÷ 4.0, about US$36.3m, a fifth higher, by year five. At the exit, the buyer's price must clear US$145m of debt before the equity receives anything.

The arithmetic is the same as capitalised interest on a development loan, and readers confuse the two. A development earns nothing until it is built or sold, so the facility funds its interest inside a limit sized for that purpose, and the sale repays it. PIK on a trading business is a pricing choice: the business has earnings, and chooses, or is allowed, to keep its cash. Interest deferred under a forbearance arrangement looks similar again, but a lender reads PIK agreed at the start of a loan differently from PIK agreed because a borrower could not pay. The first is a structure; the second is a symptom.

DEFINED IN ONE PARAGRAPH → · CAPITALISED INTEREST → · MEZZANINE FINANCE →

A senior lender to the operating company reads the holding company note as structurally subordinated, but not as irrelevant. If it falls due before the senior debt, the group faces a refinancing it may not manage, so senior lenders commonly want the note to mature after them and restrict the cash the operating company may pay upwards. Their covenants may test only the operating company's debt, which leaves the compounding note outside the ratio they read.

Agreements also differ on whether PIK interest counts in an interest cover test, and a lender checks which before reading the compliance certificate. Once signed, a borrower's election to toggle into PIK, after paying cash, is information: it tells the lender that cash has become scarce, months before any covenant would.

BANK LOAN VS PRIVATE CREDIT → · UNITRANCHE → · INTEREST COVER →