PIK interest is a non-cash interest expense, and PIK stands for payment-in-kind. Instead of deducting cash, we simply increase the debt by the amount of the interest expense. It’s like a credit card balance with a growing debt balance when interest expense is not paid.
Typically, we see PIK interest only in junior debt, such as mezzanine debt, subordinated debt, and convertible debt. “Junior debt” is higher risk than senior debt, and is usually held by PE credit funds, while senior debt is typically held by banks. PE credit funds are willing to accept a higher amount of risk in order to earn a greater return. They have the risk appetite to allow the lender to defer interest payments until the debt expires or the company is sold. The interest rate is usually much higher (15-17%) and may also contain a mix of cash and PIK interest rather than only PIK interest.