Talking credit with Mike Strathman: Capital
Why do lenders care about how much money you've invested in your business?
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I know that capital in a business shows that a business owner is committed to the business and has faith in the business. But what does capital in the business say to a lender?
Well, the lender is going be more inclined to invest in that small business owner if he or she is willing to invest in themselves.
When you're looking for capital in the business, what are you looking at?
I look at the assets and the liabilities and the equity or net worth of the business, and I want to make sure that everything is proportionate — that they have enough capital relative to the amount of debt that they have. If it's a more mature business, that they've been able to run the business profitably and grow the retained earnings, thus strengthening the balance sheet over time.
How does a small business owner get a stronger balance sheet?
First, reduce the amount of debt that you have on your balance sheet, so pay off as much of the debt as you can. Second, you can inject more capital on your own. And third, retain profits over time.
The stronger balance sheet is going to make you much more flexible and agile to take advantage of opportunities. It also is going to give you somewhat of a buffer should we have another economic downturn.
I know a lot of business owners are surprised at the connection between taking too much cash out of your business and not being able to get credit from a bank.
They want to keep a reasonable ratio of their capital to their debt. Three dollars that the company borrows, one dollar of capital. Now it will vary by industry, and it will vary by lender, but a three to one ratio is pretty good in my mind.