Payment-in-Kind (PIK)Defined with Examples & More

Written By:
Lisa Borga

What is Payment-in-Kind (PIK)?

Payment-in-kind (PIK) is a method of payment that uses goods, services, or equity in lieu of cash.

Payment-in-kind is also used to refer to a type of financial instrument in which interest or dividends are paid through granting further securities or equity in place of cash.

PIK is an attractive alternative to cash payments because it alleviates cash output for companies and often results in a greater value, albeit more risk, for the compensated party.

These are often used in performing leveraged buyouts.

Understanding Payment-in-Kind

Payment-in-kind securities is considered a kind of mezzanine financing.

This type of financing has features of both debt and equities.

Payment-in-kind securities have the advantage of a reasonably high-interest rate; however, these securities are regarded as risky.

Generally, the investors who invest in PIK securities are those investors that have the money to accept a greater than average amount of risk, such as hedge fund managers and private equity investors.

Payment-in-kind notes allow the issuer of the notes to delay making payments on the note.

However, in exchange for this delay, the issuer of the note is generally expected to give a higher return rate on the note.

Generally, PIK notes make up only a small percentage of a company’s total outstanding debts.

Additionally, payment-in-kind debt is structured to be due later than the business’s other debts, such as traditional debts or debts connected to cash dividends, thus allowing a business to pay these debts sooner, but this is risky for those financing the debt.

Therefore, financiers often impose an early payment penalty to achieve optimal earnings.

Payment-in kind also refers to the practice of accepting something other than cash for services or work.

For example, a student might accept room and board in someone’s home instead of wages for doing housework.

Individuals are required by the IRS to report the payment-in-kind income they receive through bartering on their individual tax returns.

An example of this would be a mechanic that repairs a neighbor’s car in exchange for two concert tickets.

The mechanic should record the market value of the concert tickets or his usual fee for the repairs on his income tax return.

The IRS calls payment-in-kind income bartering income.

Payment-in-Kind Example

An example of Payment-in-Kind would be an investor offering a failing business a chance to succeed by issuing the business $1 million in payment in-Kind notes.

The interest rate for the notes would be 15%, and the notes would mature in 15 years.

Every year, $150,000 in interest would be owed on the note.

But, the business would not have to pay the interest. Instead, the interest would be added to the principal, and both would be due when the note matures at the end of the 15 year period.

The amount due would increase over the 15 year period until the note is due.

What Did Payment-in-Kind Mean Originally?

Another common meaning for payment-in-kind is accepting alternatives to cash for services or work.

An example of this would be a part-time maintenance worker who gets free use of an apartment instead of wages.

The term PIK comes from the bartering system that people used before money became the accepted method of exchange.

What is Payment-in-Kind Debt?

Payment-in-Kind debt can also be financial instruments that pay investors dividends or interest.

Payment-in-kind is actually a kind of mezzanine financing that has the features of both a loan and equity.

These financial instruments generally pay a reasonably high-interest rate.

However, PIKs are considered to be a risky investment.

PIK notes allow issuers to delay payments on the notes and typically, in exchange for this delay, will pay a higher interest rate on the note.

Why Would PIK Debt Be Preferred By Some Companies?

These types of securities are sometimes chosen by companies that do not want to make cash outlays.

Typically, for most businesses, PIK notes only make up a small percentage of the business’s total outstanding debts, and the notes are structured in such a way as to be due after the other debts the company owes.

This arrangement permits the business to concentrate on paying traditional debts or debts that are connected to cash dividends first.

PIK debt is common in leveraged buyouts.

Key Highlights

• Payment-in-kind (PIK) occurs when a transaction uses goods or services as payment rather than cash.
• Payment-in-kind also refers to a type of investment in which cash alternatives are accepted.
• For tax purposes, the IRS classifies PIK as a type of bartering income that must still be reported on income tax returns.