Chapter 5 — Teaching Notes
What this chapter is doing
Chapter 5 is where Part I stops describing a restaurant and starts obligating somebody. Everything before it is analysis; this is the first chapter in which the reader signs something.
It has two jobs that pull in different directions. The first is technical: build a capital stack, amortize a note, compute and stress a coverage ratio. The second is moral, and it is the one that matters more: make students understand that a personal guarantee converts a business risk into a personal one, and that almost nobody reads it.
Teach both. A class that leaves able to compute a DSCR and unable to explain what their signature reaches has learned the easy half.
Timing
- A 75-minute session: §5.1 with Figure 5.1 and the sources-and-uses statement (20 min) → §5.3's
correction that the SBA does not lend, plus Figure 5.3 (15 min) → §5.4 amortization and the
interest/principal split (15 min) → the DSCR
🧮 Run the Numbers, worked live including the stress table (25 min). Assign §5.2, §5.5, §5.6, §5.7 as reading. - Two sessions: split after §5.4. Session two is the money-that-doesn't-call-itself-a-loan session — landlord, lessor, vendor, family — and it is the one students enjoy, because every example is something they have seen.
- Self-paced: 5–7 hours including exercises.
Common misconceptions
1. "The SBA gives you the loan." Nearly universal, including among students who have worked in restaurants. Correct it in the first ten minutes and keep correcting it, because everything downstream depends on it: why two lenders give different answers, why lender experience matters more than a quarter point, why the guaranty does not protect you. The line that fixes it: the SBA guaranty protects the lender from you; your personal guarantee protects the lender from you. Same direction.
2. "A lower rate is a better loan." Students optimize rate reflexively. Exercise 5.12 is built to break the habit — the seven-year loan has the better rate and costs \$6,228 more a year in cash. Introduce the constant (cents of annual payment per dollar borrowed) early and use it constantly; it is the single most portable idea in the chapter.
3. "Debt service is an expense." The interest/principal split in §5.4 is where restaurant accounting gets genuinely counterintuitive. In year one, \$34,230 of a \$54,244 payment is an expense and \$20,014 is not — it is cash out with no P&L consequence at all. Students nod and then get it wrong on the exam. Put the ten-year table on the board and ask them to find the year in which the "invisible" cash outflow is largest. (Year ten: \$51,263.)
4. "A high DSCR means the plan is good." Bellwether projects 3.76, which feels like an A. Push back hard. A projection's coverage ratio measures whether the forecast is internally coherent, not whether it is true. Exercise 5.17 is the antidote and it lands hard: a plan showing 2.19 drops to 0.78 the moment you pay the owners a market wage.
5. "Landlord money and vendor equipment are free." Both are loans that do not quote a rate. Students accept the TI allowance as a gift until you make them amortize it (\$2.68 to \$3.90 a square foot a year, for ten years) and accept the free espresso machine until they compute \$6,240 for a \$4,500 asset.
6. "Family money is simpler." It is faster and it is not simpler. Students are surprised that a handshake with a cousin is a securities offering. It reliably generates the best discussion in the chapter.
The hardest point to teach
That a personal guarantee is not a formality.
Students in their twenties have signed apartment leases and student-loan paperwork and have absorbed the idea that documents are things you sign to get the thing you want. The guarantee is not that. It is unlimited, unconditional, joint and several, and it survives the business.
What works is the arithmetic of exposure, done on the board with no commentary:
Owner injection, both partners $150,000
────────────────────────────────────────────────────────────────
SBA note, personally guaranteed $335,000
Ten-year lease at $95,200/yr, personally guaranteed ~$950,000
Equipment lease, usually guaranteed $60,000
────────────────────────────────────────────────────────────────
Personally guaranteed, against $150,000 invested ~$1,345,000
Write the ratio — roughly nine dollars of personal exposure for every dollar invested — and then stop talking. Let the room sit with it. Someone will ask whether that can possibly be normal. The answer is yes, it is the ordinary case, and it is why Chapter 39 exists.
Follow it with the practical instruction, which is the actual takeaway: read the guarantee before you read the loan agreement, and pay an attorney to read it with you.
A demonstration that works
Break the coverage ratio live.
Put Bellwether's plan figures on the board: \$261,020 of operating profit, \$69,500 of debt service, DSCR 3.76. Ask the room whether the plan is safe. They will say yes.
Then build the stress model with them, in this order, taking a vote after each step:
- Split the cost structure — 66.0% of sales moves with volume, \$265,980 does not. Verify it reproduces \$261,020 exactly. (This step matters: students trust a model they watched reproduce a known answer.)
- Solve for DSCR 1.00. It comes out at \$986,700 — 63.7% of plan, roughly sixty dinner covers a night instead of ninety-five. Most rooms are surprised at how much room there is.
- Then take it away. Point out that the model treats all labor as variable and ask what actually happens to labor cost at sixty covers. Someone will say the salaried floor does not move. Correct answer: the true break point is higher than \$986,700, and this model was optimistic.
- Finally, ask whether the owners are paid inside the \$500,000 labor line, and what the ratio means if they are not.
The sequence — confident, then quantified, then undermined by its own assumption, then undermined again — is the chapter's argument in miniature, and it teaches skepticism about models better than any lecture about skepticism about models.
Extension if you have time: hand out the sources-and-uses statement from Figure 5.2 with two numbers deleted and have students reconstruct them from the requirement that it foot in both directions. It takes four minutes and it permanently fixes the idea that the statement is a constraint, not a summary.
Assessment notes
- Exercises 5.8, 5.10, 5.12, 5.15, and 5.19 are the computational core. A student who can do those five can read any funding package they will encounter.
- Exercise 5.17 is the single best diagnostic in the chapter. It requires no new technique and it separates students who compute from students who think. Grade it on the two sentences, not the arithmetic.
- Exercise 5.24 (the "free" draft system) reliably produces the largest gasp-per-minute ratio.
- Exercise 5.32 (the memo to a family member) is the best writing prompt. Look for students who resist the urge to persuade — the brief says the memo's job is to make the reader able to choose, and most first drafts sell.
- Exercise 5.34 is the strongest Business Plan extension and works well as a graded assignment. It requires the reserve arithmetic, the debt constants, and a judgment about which source to tap, with a cost stated honestly.
A note for the instructor on the running project
Chapter 5 stops at "submitted." The plan has an ask, a stack, a coverage ratio, and an application package. It does not have an answer, and the chapter is written so that it cannot be inferred. Students will ask. The correct response is that this is exactly the position a real applicant is in for weeks or months, and that the open questions — the unsigned lease, the contingency, the reserve, the labor line, the revenue gap — are the material a lender is working through while the applicant waits.
Resist the temptation to hint. The capstone in Chapter 40 assembles the whole document and states the disposition, and the argument it provokes is much better if the class has genuinely had to sit with uncertainty first.
Connections forward
Flag these explicitly. The guarantee → Chapter 39. The lease terms priced here → Chapter 6. The construction contingency question → Chapters 6 and 7. The reserve → Chapter 33. The labor line the coverage ratio depends on → Chapter 19. The revenue gap → Chapters 22 and 24. Fixed versus variable cost, done properly → Chapter 32. Where debt service appears on the statements → Chapter 31. Vendor financing inside payment processing → Chapter 26. The completed plan → Chapter 40.