Interest paid in kind is paid at closing

For an owner whose company borrows from a private-credit fund, September's rate increase is a reason to check the loan balance as well as the rate. On September 16 the Federal Reserve raised its target range for the federal funds rate by a quarter point, to between 3.75% and 4.00%, its first increase since July 2023.^[1][2] The minutes of that meeting, released October 7, said most participants judged that another increase would likely be appropriate by year end, while stressing that decisions would depend on incoming information.^[3] Our conclusion is practical: before agreeing a price, an owner should know what each loan will cost to repay on the day of closing, including the interest that has been added to it.

More interest is being added to loans

Payment in kind, or PIK, lets a borrower add unpaid interest to its loan principal instead of paying cash each quarter.^[4] The Federal Reserve Bank of Boston reported in August that the share of loans held by business development companies with PIK rose from about 6% to roughly 10% by early 2026, after a steady increase since early 2022, and read the rise as a sign of growing pressure on borrower cash flows.^[4] Moody's put PIK at roughly 8% of gross investment income at public business development companies, up from about 5.5% in 2021, and said the rise is not evidence of distress in itself.^[5]

The distinction matters. PIK agreed when a loan is made is a different thing from PIK added later because cash is short. Lincoln International, which values private loans each quarter, found that 6.2% of all the loans in its second-quarter review carried PIK interest they had not carried at closing, a share it says may also be viewed as a shadow default rate.^[6] These measures cover different portfolios and periods. Together they say that a growing part of private-credit interest is being settled later rather than paid now.

The balance is settled from the proceeds

Later usually means at the sale. A change of control is an event of default under US credit agreements, and loans that can stay in place after a change of ownership remain rare in middle-market transactions, so a sale normally means repaying the lender at closing.^[7] The repayment is treated as voluntary and can carry the agreed prepayment premium, although the market has moved toward reducing that premium for a change of control.^[7]

The payoff covers the whole balance, and the interest added to principal has itself been earning interest. As an illustration, 4% a year added to a $50 million loan would make it $52 million after one year and about $54.1 million after two, before any cash interest. In a price agreed for the whole company, each of those dollars comes out of what shareholders receive. Borrowers have asked lenders to exempt the repayment of capitalized PIK interest from prepayment premiums, which lenders typically resist, according to Proskauer.^[8]

Show the payoff before the price

Ask each lender for a payoff statement at the likely closing dates: principal, interest added to principal, accrued interest, fees and any premium, and how a change of control affects the premium. Have counsel confirm what the credit agreement requires.

Then show the buyer how the balance has moved. A quarterly schedule from the original loan to today should separate cash interest from interest added to principal, and show whether the PIK was agreed at closing or added by amendment. A buyer and its lenders are likely to read the two differently, as Lincoln's measure does.^[6]

In the purchase agreement, define indebtedness to include interest added to principal, accrued interest and any premium, so that the step from enterprise value to the equity price is settled before exclusivity rather than in the closing statement. None of this requires a view on the next rate decision. It requires knowing what the loan will cost to repay on the day the company changes hands.