Payment-in-Kind (PIK) involves allowing the use of a good or service rather than making a cash payment. Payment-in-kind is a financial tool that offers more securities or equity shares to its investors or stockholders as dividend or interest earned on bonds, shares, etc. instead of paying them via cash. Organizations that are not keen to have cash outflows prefer using payment-in-kind securities. Instead, they can use this cash in leveraged buyouts.
A Little More on What is Payment-in-Kind
Payment-in-kind securities refer to a form of mezzanine financing that involves attributes of both equity and debt. They carry higher risks levels followed by higher interest rates or yields. Investors, like hedge funds managers and private equity investors, who can afford to invest in extremely risky investments usually participate in payment-in-kind securities.
Payment-in-kind notes offer the issuing company an opportunity to hold up cash dividend payments for a while. However, for making investors wait for sometime, the firm agrees to provide a better return on the investment or note.
Working of Payment-in-Kind Notes
Let’s suppose a finance officer issuing a payment-in-kind of $2 million to a budding firm. The note carries an interest rate of 10% and has a maturity period of 10 years. As per the interest rate provided, the note will carry an interest of $200,000 every year. Instead of paying the monthly instalments or making repayments, the borrower can pay the whole amount of principal and the accumulated interest at the time of maturity of loan, when the cash becomes due. So, the company will owe $2.2 million (principal as well as interest) at the end of first year.
Payment-in-kind vs Trade and Barter
One can offer payment-in-kind as a cash alternative for the tasks done or services performed. For instance, a helper who is assisting a farmer in cultivation can receive a free accommodation instead of hourly pay rate.
(Note: The Internal Revenue Service (IRS) considers payment-in-kind as bartering income)
As per the IRS, individuals who obtain payment-in-kind income via bartering should include it in their tax return. For instance, a plumber offering repair services to a customer, and accepting meat in exchange for the services offered, should include the market value of meat, or his general service fee in income tax statements as a source of income.
Most of the times, payment-in-kind notes consist of a portion of the cumulative outstanding debts of a firm, and the financial experts issue these notes in such a manner that they expire post the other debts of the firm. This enables the firm to emphasize on making repayment of previous debts or the ones associated with cash dividends in a steady manner. However, this leads to increasing the financier’s risks. For avoiding such risks, financiers specify penalty involving earl payments in order to enhance their future earnings.
- Payment-in-kind (PIK) involves using a good or service rather than cash.
- The term ‘payment-in-kind’ implies to taking cash alternatives for work performed or services rendered.
- The Internal Revenue System (IRS) considers payment-in-kind as income earned from barter, and asks individuals to disclose such income at the time of filing income tax returns.