Opening a Ghost Kitchen? Know the Laws That Will Impact Your Business

The COVID-19 pandemic has reshaped the way restaurants do business. Many areas across the country are in the midst of a “second lockdown,” as state and local governments are again restricting businesses with indoor dining to help curb COVID-19’s spread. The second lockdown, together with the first (occurring in areas throughout the country in the second quarter of 2020), has helped accelerate a new restaurant business model—the ghost kitchen.

Are you considering operating a ghost kitchen? Are you wondering what laws apply to this business model? Let’s examine the most important laws that impact your ghost kitchen business.

What Is a Ghost Kitchen?

Ghost kitchens are professional food preparation and cooking facilities set up for the preparation of takeout or delivery-only meals. The name “ghost kitchen” is alternatively called a delivery-only restaurant, online-only restaurant, delivery kitchen, virtual kitchen, shadow kitchen, commissary kitchen, dark kitchen, ghost line, or cloud kitchen. 

Ghost kitchens were gaining some traction even before COVID-19, but the shelter-in-place and stay-at-home governmental orders forced most traditional restaurants to really consider the ghost kitchen as a business model. Restaurant businesses found themselves offering new curbside and delivery services and leveraged the marketing value of social media to attract attention and stay viable in an uncertain time. Some restaurants were faced with too much indoor dining space, resulting in a need to utilize space differently, often with “pop-up” options. 

Considerations for Operating a Ghost Kitchen Now

If the pandemic has affected your business to the point that you are thinking about or even currently operating a ghost kitchen, it’s essential to know the legal aspects of this business model.  The legal hurdles common to restaurant business owners are magnified when viewed through the lens of operating a ghost kitchen. 

Of utmost importance are three legal considerations:

1. Corporate formation
2. Leasing issues
3. Local ordinances and regulations

Beyond these three significant considerations, you will also need to be aware of franchise disclosure laws and trademark filings, among other issues, as you expand and reshape your business into a ghost kitchen. 

What Type of Corporate Formation Is Right for a Ghost Kitchen?

There are three types of corporate formation:

1. Sole proprietorships/general partnerships
2. Limited Liability Company
3. C-Corporation

The Sole Proprietorship Option Lacks Individual Liability Protection

Sole proprietorships and general partnerships are not the best option for a restaurant owner looking to expand into a ghost kitchen model. While sole proprietorships offer tax benefits for small businesses, the structure does not offer protection from individual liability, because it does not separate from a franchisee's personal legal identity. Accordingly, any claims brought against a ghost kitchen would create enormous personal liability.

The Limited Liability Company (LLC) Option Is the Best Bet for Ghost Kitchens

LLCs tend to be the best bet for startup ghost kitchens, especially those looking to expand. LLCs shield against individual liability while providing significant tax benefits. Further, LLCs can be designated as flow-through entities, which means no corporate income tax returns need to be filed – all net income is taxed at the individual level.

That said, LLCs offer somewhat limited flexibility as independent legal entities and have few statutory requirements governing them. They do not offer much for an expanding ghost kitchen with equity investors. Expanding businesses (especially franchises) under LLCs run into challenges when issuing equity to investors because they are not distributed in the same structure as corporations. Moreover, if a franchisee has multiple investors into a franchise, LLCs become more complex from a tax perspective.  

The C-Corporation Option Is Ideal for Established Businesses, but not for Ghost Kitchens

C-Corporations are more ideal for large, established businesses than for a start-up ghost kitchen. The goal of any C-Corporation structure is to position a business for future growth by soliciting additional capital investment from investors. C-Corporations are used primarily for their equity distribution for investors. Most commonly used for publicly traded companies with several equity investors and executive boards, the C-Corporation structure may be troublesome for ghost kitchens or startup franchisors because C-Corporations are taxed at both the corporate and individual levels.  

Ghost Kitchens Come with Complex Leasing Issues 

Restaurant leases are complex agreements that typically involve hard-fought negotiations. In the ghost kitchen context, where a space is likely shared with another business, the complexities are even greater. Often, ghost kitchen leasing issues involve questions of subleasing, which raise an added layer of issues to negotiate. Therefore, it is imperative that every restaurant tenant carefully reviews and considers lease terms and corresponding business plans. If material terms are not structured and agreed to at the outset, a ghost kitchen may risk a landlord permanently closing its operations.

Know Your Local Ordinances/Regulations and Permits

Generally, a city’s health department and planning department will regulate the operation of restaurants, and the same is true for ghost kitchens, as all business and health standards and codes continue to apply to a ghost kitchen’s business operations. In addition, it is likely that you will need to obtain several licenses or permits from a jurisdiction that allow you to carry on the ghost kitchen’s activities. These licenses can include:

• Business operation
• Alcohol
• Live entertainment
• Food service
• Building occupancy
• Employer identification number
• Employee health

Moreover, you will need to renew your licenses on a regular basis. A business license or permission to serve alcohol usually requires an annual renewal. Of course, just having the license doesn’t mean you can automatically keep it, and so it is critical to understand any additional requirements associated with your licenses. 

In closing, operating a restaurant as a ghost kitchen, particularly while businesses are under pandemic-related restrictions, can be a good business model for many. If this model interests you, it is advisable to take the time for careful consideration of the corporate formations available, and to have a good understanding of leasing complexities as well as jurisdictional licensing and permit requirements.