When using PIK, how is interest treated?

When employing Payment-in-Kind (PIK) financing, interest is treated by being added to the loan balance. This means that instead of making immediate cash payments, the borrower does not pay the interest currently due. Instead, that interest is effectively capitalized, resulting in an increased principal amount owed.

PIK financing is particularly useful for borrowers who may not have sufficient cash flow to meet their interest obligations during the term of the loan. By adding the interest to the loan balance, it allows the borrower to manage their cash flow more effectively while accessing the necessary financing for their projects.

In this context, the other treatment options for interest are not applicable to PIK structures. Interest is not paid in cash immediately, as that would contradict the nature of a PIK loan. It is also not converted into equity, which would imply a different financing arrangement like some forms of convertible debt. Lastly, while interest can be deferred in certain contexts, in PIK financing it is specifically capitalized rather than left unpaid indefinitely without accruing onto the loan balance.