PIK Interest in an LBO

How does PIK change debt balances and sponsor returns?

Compare paying interest in cash with adding it to principal in the LBO Model. The initial 4,000 debt and 5,700 sponsor funding are identical. PIK avoids that interest cash payment during the holding period, but the accumulated liability still reduces exit equity.

Supply comparable interest structures

All money is EUR thousands. Example Company has 2026 actuals and forecasts for 2027–2031. Annual revenue 4,000 less COGS 2,000 and overhead 400 gives EBITDA 1,600. D&A and capex are 200 each, EBIT 1,400 and tax rate 25%. Working-capital changes and other operating inputs are zero; unlevered FCFF is 1,050 each year. Opening PP&E and equity are 5,000 each. NOL use is disabled; deal tax is paid in the same period.

Entry is after 2026 and exit after 2031: five years under the actual model-period dates. Entry and exit use reported EBITDA and 6× unless a case explicitly changes them, so each base EV is 9,600. Acquisition cash is explicitly overridden to 100 and existing debt to zero; other entry and exit bridge items and exit fees are zero. Purchase equity is 9,700. This acquisition cash is a supplied deal assumption, not the default book-year cash.

Case A is one 4,000 tranche with 8% cash interest and 0% PIK. Case B has 0% cash interest and 8% PIK on the same amount. Case C combines 2,500 at 8% cash interest with 1,500 at 8% PIK. All use Amount, no amortization, maturity 2033 and no sweep eligibility; global sweep is 0%. Minimum cash is 100. Rollover, management dilution, fees and distributions are zero. PIK deductible is on in Deal tax policy. These equal supplied rates isolate payment mechanics; they are not market quotes.

Follow capitalized interest over the five periods

In B, the first period opens at 4,000, accrues PIK 320 and ends at 4,320. The next period accrues 4,320 × 8% = 345.60, ending at 4,665.60. With no repayment, capitalization repeats until exit debt is 5,877.31. The engine applies PIK to opening principal and the actual period-year fraction; these calendar annual periods each have a fraction of one.

Case A pays 320 cash annually and principal remains 4,000. Case C pays 200 cash in its first period and accrues 120 PIK on the separate junior tranche. Cash-pay principal stays 2,500; the PIK balance reaches 2,203.99. The schedules below report engine amounts, not a second debt calculator.

Reconcile retained cash and the exit liability

In the first year, A generates deal cash 810 after cash interest and tax. B generates 1,130 because there is no interest cash payment and the deductible PIK reduces tax by 80; it ends with 1,230 including opening cash 100. Over five years A ends with cash 4,150; B with 5,819.33.

Cash preserved is 1,669.33, but additional exit debt is 1,877.31. At the same EV 9,600, sponsor proceeds therefore fall from 9,750 to 9,542.02. B’s MOIC is 1.6740× and dated IRR 10.8544%, versus 11.3335% for A. Tax assumptions matter; deferring cash interest is not free funding.

Reproduce cash-pay, PIK and mixed debt

1. Download cash-pay, PIK and mixed native examples and explicitly import them through Manage models → Import. In Model, switch to Advanced before editing, then return to Deals → LBO. A blank workspace may require Activate; the imported files already have LBO active. The CTA opens your workspace and does not import a file automatically.

2. Open Debt structure. For A check Amount 4,000, Cash rate 8%, PIK 0%. For B use Cash rate 0%, PIK 8%; otherwise keep terms identical. C has two Amount tranches, 2,500 cash-pay and 1,500 PIK. Under Cash / debt paydown keep minimum cash 100 and sweep 0%.

3. In Deal tax policy confirm PIK interest deductible is selected and no NOL use in the operating model. Compare cash interest, PIK, closing cash and debt in Cash / debt paydown and proceeds in Sponsor returns. Changing A’s two rates to 0% cash / 8% PIK reproduces B without changing funding or operating inputs.

Separate interest accrual from financing design

Debt Model develops broader debt schedules; LBO Capital Structure compares financing layers. To add repayments from available cash, use LBO Cash Sweep. MOIC vs IRR explains the return measures.

The example does not price credit, test covenants, interpret debt documents or recommend refinancing. PIK deductibility here is a supplied model policy, not a conclusion about tax law. Debt maturing during the hold creates mandatory repayment; an unfunded payment makes MOIC and IRR unavailable.