PE InterviewTechnical
PIK interest
Explain how payment-in-kind interest works and where it shows up in the statements.
Direct answer
PIK interest accrues to the principal instead of cash; it boosts leverage today and cash flow later until repayment.
Step-by-step
Walk through the structured answer
1
Definition and instruments
PIK toggles on mezzanine or holdco notes let issuers add accrued interest to principal rather than pay cash.
2
Income statement impact
Interest expense still reduces pre-tax income; there’s no operating cash outflow in PIK periods.
3
Cash flow and balance sheet
Add back non-cash interest to CFO; debt principal increases on the balance sheet to reflect accrued PIK.
4
Use cases and risks
Helpful in tight liquidity periods but raises leverage and refinancing risk at exit; often costs more than cash pay.
Pitfalls to avoid
- Treating PIK as free capital without modeling higher leverage at exit.
- Ignoring covenants that restrict toggling between cash pay and PIK.
- Missing tax deductibility limits when interest is PIK.
Follow-up angles
- How would PIK change the LBO base case vs. downside?
- What signals to lenders that PIK risk is acceptable?
- How does PIK affect cash sweeps and amortization?
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