Complex Financings

A PIK loan, or payment-in-kind loan, is a loan where the interest on it is paid not in cash but by increasing the loan amount. The debt increases with time and the full repayment of the debt takes place at maturity of the loan, often from a refinancing or when (part of) the business or an asset is sold. This way, the business keeps its cash during its growth phase, while integrating an acquisition or while waiting for the right time for a comprehensive refinancing. As the lender receives no cash interest under a PIK loan, the interest rate on a PIK loan is higher than the interest rate on cash-pay debt.

A HoldCo PIK loan is a loan provided not to the operating company that operates the business but to a holding company that holds the shares in the operating company. It is structurally subordinated to the debt of the operating company and is secured on the shares of the operating company. Interest payments are usually capitalised using payment-in-kind (PIK) interest or a PIK toggle because the holding company has no cash flow of its own before receiving dividends or selling (part of) the shares in the operating business. A HoldCo PIK loan allows a group of companies to raise debt without increasing the debt at the level of the operating company. If the capital raised at the HoldCo level is used to subscribe to a primary capital increase/new shares of the operating company, the HoldCo PIK loan will be debt at the HoldCo level but equity at the operating company level, which can support lower financing costs or terms at the operating company level.

A PIK toggle allows the borrower to choose for each interest period to either pay the interest in cash or to capitalise it (payment-in-kind). The PIK toggle suits a holding company where the ability to pay interest depends on dividends received from its operating companies, which may vary each year. Usually, the decision to capitalise the interest will cost the borrower more, for example, via an increased interest rate for this period.

Mezzanine debt sits between senior debt and equity. It is generally used when the senior debt offered by banks is insufficient for the capital needs of the company but the owner of the business does not want to raise equity. It generally requires relatively stable cash flows and/or assets that can be pledged and sold in case of an event of default. Cash-pay mezzanine debt pays its interest in cash, usually quarterly, and therefore the borrower must have spare cash flow to pay it. PIK mezzanine capitalises the interest instead of paying it, which is appropriate for businesses which need to preserve their cash flow, e.g. fast-growing businesses or those that integrate an acquisition. Many mezzanine loans use both options: part of the interest is paid in cash and part of the interest is capitalised. The trade-off here is the cost: the more interest is deferred, the higher the return required by the lender.