<PAGE>

                                                                    EXHIBIT 10.7


                          Raleigh Industries Limited
                                                             (1)

                                     -and-


                                Phillip Darnton
                                                             (2)







                               SERVICE AGREEMENT

                             as Managing Director







                                    Lovells
                              65 Holborn Viaduct
                                London EC1A 2DY

                                  B2/MJTS/NMF
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                                   Contents

<TABLE>
<CAPTION>
Clause                                                 Page no
<S>                                                    <C>

 1.  APPOINTMENT AND TERM                                    1

 2.  DUTIES                                                  1

 3.  REMUNERATION AND BONUS                                  2

 4.  PENSION AND INSURANCE BENEFITS                          3

 5.  EXPENSES                                                4

 6.  MOTOR CAR                                               4

 7.  RELOCATION EXPENSES                                     4

 8.  HOLIDAYS AND HOLIDAY PAY                                4

 9.  SICKNESS/INCAPACITY                                     5

10.  CONFIDENTIAL INFORMATION                                5

11.  INVENTIONS                                              5

12.  RESTRICTIVE COVENANTS                                   5

13.  PAYMENT ON TERMINATION                                  7

14.  TERMINATION ON THE HAPPENING OF CERTAIN EVENTS          8

15.  OBLIGATIONS UPON TERMINATION OF EMPLOYMENT              8

16.  OTHER TERMS AND CONDITIONS                              9

17.  DEFINITION                                             10

18.  APPLICABLE LAW                                         10
</TABLE>
<PAGE>

                               Service Agreement

This Agreement made the  11th  day of  August  2000

Between:

(1)  Raleigh Industries Limited (Registered Number 139076) whose registered
     office is at Triumph Road, Nottingham, NG7 2DD (the "Company") and

(2)  Phillip Darnton of 75 Limerston Street, London SW10 0BL (the "Executive").

Whereas:

The Company wishes to employ the Executive and the Executive has agreed to serve
the Company as Managing Director on the terms and conditions set out in this
Agreement.

It is agreed:

1.   Appointment and term

1.1  The Company shall employ the Executive and the Executive shall serve the
     Company as Managing Director with effect from 4 January 2000.  During the
     first year of the Executive's employment hereunder, either the Executive or
     the Company may terminate the employment at any time by giving to the other
     not less than six calendar months' notice in writing. Thereafter, either
     the Executive or the Company may terminate the employment at any time by
     giving to the other not less than one year's notice in writing.  The
     Company reserves the right to terminate the Executive's employment by
     payment of a sum equivalent to the amount of the Executive's net salary and
     the value of other contractual benefits during his notice period.

1.2  The Executive shall be a member of the Derby Cycle Corporation Executive
     Board of Directors and shall be entitled to receive notice of and shall
     attend all meetings thereof.


2.   Duties

2.1  During his employment hereunder the Executive shall:

     (a)  perform the duties and exercise the powers and functions which from
          time to time may reasonably be assigned to or vested in him by the
          Group Chief Executive of the Derby Cycle Corporation (the "Group Chief
          Executive") in relation to the Company and any Associated Company (as
          herein defined) at such place or places both within and outside the
          United Kingdom as the Group Chief Executive or the Board of Directors
          of the Company ("the Board") shall determine;

     (b)  unless prevented by sickness, injury or other incapacity, during
          working hours devote the whole of his time, attention and ability to
          his duties hereunder and shall faithfully
<PAGE>

          and loyally serve the Company to the best of his ability and use his
          utmost endeavours to promote its interests in all respects;

     (c)  comply with all reasonable requests, instructions and regulations
          given or made by the Group Chief Executive (or by any one authorised
          by him) and promptly provide such explanations, information and
          assistance as to his activities or the business of the Company as the
          Group Chief Executive (or the Board) may reasonably require; and

     (d)  not engage in any activities which would detract from the proper
          performance of his duties hereunder, nor without the prior written
          consent of the Group Chief Executive in any capacity including as
          director, shareholder, principal, consultant, agent, partner or
          employee of any other company, firm or person (save as the holder for
          investment of securities which do not exceed three per cent (3%) in
          nominal value of the share capital or stock of any class of any
          company quoted on a recognised stock exchange) engage or be concerned
          or interested directly or indirectly in any other trade, business or
          occupation whatsoever.

2.2  Without prejudice to the provisions of clause 2.1 (b) and (d), the
     Executive may (with the prior written consent of the Group Chief Executive)
     in the first two years' of his employment hereunder devote up to ten
     working days' per annum to service in his role as a non-executive director
     of non-group companies provided that such activities do not give rise to
     any conflict of interest.  The foregoing limit will be reviewed on the
     second anniversary of the commencement of the Executive's employment
     hereunder.

2.3  Notwithstanding the provisions of clause 2 the Company shall:

     (a)  (in the event of the Executive's absence from work for a consecutive
          period of three months by reason of illness, accident or other
          incapacity) be entitled at any time to appoint another person or
          persons to act jointly with the Executive;

     (b)  have the right to require the Executive at any time to carry out such
          special projects or functions commensurate with his abilities as the
          Company shall in its absolute discretion determine; and

     (c)  be under no obligation to assign to or vest in the Executive any
          powers, duties or functions or to provide any work for the Executive
          and may at any time suspend the Executive from the performance of any
          duties or exclude him from any premises of the Company.

3.   Remuneration and bonus

3.1  As remuneration for his services hereunder the Company shall pay to the
     Executive a salary at the rate of one hundred and fifty thousand pounds
     ((Pounds)150,000) per annum (which shall be deemed to accrue from day to
     day) payable in arrears by equal monthly instalments on the

                                      -2-
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     fourteenth day of each month such salary being inclusive of any fees to
     which the Executive may be entitled as a director of the Company or of any
     Associated Company. The said salary shall be reviewed annually by the Board
     by no later than the end of the first quarter of each calendar year and the
     rate thereof may be increased (but not, without the Executive's consent,
     decreased) with effect from 4 January in that year.

3.2  The Executive will be entitled to be a member of the Derby Cycle
     Corporation Executive Bonus Scheme ("the Bonus Scheme").  Any payments
     under the Bonus Scheme are entirely discretionary and will be made in
     accordance with the terms of the Bonus Scheme.

3.3  Without prejudice to the Company's discretion in respect of the Bonus
     Scheme, the Company will pay the Executive a guaranteed bonus of at least
     (Pounds)75,000 (subject to the deduction of any tax, national insurance and
     any other deductions) in respect of the first year of his employment
     hereunder.  This bonus (the final amount of which will be determined by the
     Group Chief Executive in his absolute discretion and will be dependent on
     the performance of the Company) will be paid on or about 15 April 2001 and
     is conditional upon the Executive still being employed by the Company on 31
     December 2000 and not working out any period of notice given by him.  For
     the avoidance of doubt, the Executive shall not be entitled to any pro rata
     proportion of this bonus payment if he is no longer employed by the Company
     on 31 December 2000.

3.4  For the purposes of the Employment Rights Act 1996 and otherwise the
     Executive hereby consents to the deduction of any sums owing by him to the
     Company at any time from his salary or any other payment due from the
     Company to the Executive and the Executive hereby also agrees to make any
     payment to the Company of any sums owed by him to the Company upon demand
     by the Company at any time.

4.   Pension and Insurance Benefits

4.1  The Executive shall be entitled to be a member of the contributory Raleigh
     Pension Scheme and the non-contributory Raleigh and Sturmey-Archer
     Executive Pension Scheme, particulars of which are set out in the Company's
     letter to the Executive dated 15 December 1999 (a copy of which is attached
     as Schedule I).  The Executive's membership of the said schemes shall be
     subject to the provisions thereof as amended from time to time.

4.2  The Company shall provide the Executive with medical insurance (details of
     which are available from the Personnel department) in respect of him and
     (in the event of his marriage) his spouse and any dependent children.  The
     Company shall also provide the Executive with life assurance (in accordance
     with the terms of the Raleigh and Sturmey-Archer Executive Pension Scheme).
     The Company shall have the right to change its arrangements for the
     provision of such benefits, but shall continue to provide benefits of a
     reasonably equivalent nature and value.

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4.3  The Executive agrees that the maximum weekly working time as set out in
     regulation 4 of the Working Time Regulations 1998 shall not apply in
     relation to his employment.  This condition shall apply indefinitely
     subject to the Executive's right to withdraw his agreement to the exclusion
     of the maximum weekly working time on providing three months' written
     notice.

5.   Expenses

     The Company shall reimburse to the Executive all travelling, hotel,
     entertainment and other expenses properly and reasonably incurred by him in
     the performance of his duties hereunder and properly claimed and vouched
     for in accordance with the Company's expense reporting procedure in force
     from time to time.

6.   Motor car

     The Company shall provide the Executive with a motor car appropriate to his
     status in accordance with the Company's current car scheme policy for his
     business and personal use. The Company shall pay all taxation, insurance
     premiums, maintenance and repair expenses. Upon termination of his
     employment for whatever reason or if the Executive ceases for any reason to
     hold a valid driving licence the Executive shall forthwith return the motor
     car to the Company.

7.   Relocation expenses

     The Company will either provide the Executive with temporary accommodation
     in Nottingham for a period of 12 months from 4 January 2000 or reimburse to
     the Executive relocation expenses properly and reasonably incurred by the
     Executive in moving to Nottingham on or before 3 January 2001. The maximum
     amounts paid by the Company in respect of such temporary accommodation
     and/or relocation expenses will together be no more than (Pounds)35,000
     (net of any taxes). After the said period, the cost of any accommodation
     for the Executive (or any relocation expenses) will be reviewed by the
     Company, taking account of the then current circumstances.

8.   Holidays and holiday pay

8.1  In addition to the normal Bank and public holidays the Executive shall be
     entitled to 25 working days' paid holiday during each calendar year to be
     taken at such time or times as may be agreed with the Group Chief
     Executive.  The Executive may not without the consent of the Board carry
     forward any unused part of his holiday entitlement to a subsequent calendar
     year.

8.2  For the calendar year during which the Executive's employment hereunder
     commences or terminates he shall be entitled to such proportion of his
     annual holiday entitlement as the period of his employment in each such
     year bears to one calendar year.  Upon termination of his employment for
     whatever reason he shall if appropriate either be entitled to salary in

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     lieu of any outstanding holiday entitlement or be required to pay to the
     Company any salary received in respect of holiday taken in excess of his
     proportionate holiday entitlement.

9.   Sickness/incapacity

9.1  If the Executive shall be prevented by illness, accident or other
     incapacity from properly performing his duties hereunder he shall report
     this fact forthwith to the Personnel department and if he is so prevented
     for more than seven consecutive days he shall if required by the Company
     provide an appropriate doctor's certificate.

9.2  If the Executive shall be absent from his duties hereunder owing to
     illness, accident or other incapacity duly certified in accordance with the
     provisions of clause 9.1 he shall be paid his full remuneration for the
     first six months of such absence and thereafter subject to the provisions
     of clause 14 such remuneration as the Board shall in its discretion allow
     PROVIDED THAT there shall be deducted from such remuneration any Statutory
     Sick Pay or any social security or other benefits payable to the Executive
     including any sums recoverable from a third party.

10.  Confidential information

     The Executive shall not during his employment hereunder (save in the proper
     course thereof) or at any time after its termination for any reason
     whatsoever disclose to any person whatsoever or otherwise make use of any
     confidential or secret information which he has or may have acquired in the
     course of his employment concerning the business, affairs, finance,
     customers or trade connections of the Company or any Associated Company or
     any of its or their suppliers, agents, distributors or customers and shall
     use his best endeavours to prevent the unauthorised publication or
     disclosure of any such confidential or secret information.

11.  Inventions

     Subject to the Patents Act 1977 and the Copyright, Designs and Patents Act
     1988 any invention, design or copyright work made by the Executive during
     the course of his employment by the Company whether or not in the course of
     his duties and whether for the Company or any Associated Company shall be
     the exclusive property of the Company and the Executive undertakes at the
     expense of the Company to execute any formal and additional assignment
     required by the Company to vest or confirm the vesting in it or its nominee
     of all rights in any such invention, design or copyright work.

12.  Restrictive covenants

12.1 Since the Executive will in the course of his employment hereunder have
     dealings with customers and obtain knowledge of trade secrets and other
     confidential information in regard to the business of the Company and its
     Associated Companies, the Executive hereby agrees and undertakes with the
     Company for itself and as trustee for its Associated Companies that

                                      -5-
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     he shall not without the prior written consent of the Board (such consent
     to be withheld only so far as may be reasonably necessary to protect the
     legitimate interests of the Company or any Associated Company):

     (a)  for a period of 12 months after the termination of his employment
          hereunder be engaged or interested (whether as a director,
          shareholder, principal, consultant, agent, partner or employee) in any
          business concern (of whatever kind) which shall in the United Kingdom
          and Eire be in competition with the Company or with any Associated
          Company in the manufacture, exporting, importing, sale, supply,
          marketing or distribution of bicycles, bicycle parts or accessories of
          a kind with which the Executive was concerned to a material extent
          during the period of one year prior to the termination of his
          employment with the Company PROVIDED ALWAYS that nothing in this
          clause 12.1(a) shall restrain the Executive from engaging or being
          interested as aforesaid in any such business concern in so far as his
          duties or work relate principally to goods of a kind with which the
          Executive was not concerned during the period of one year prior to the
          termination of his employment hereunder;

     (b)  for a period of 12 months after the termination of his employment
          hereunder either on his own behalf or on behalf of any other person,
          firm or company in respect of any goods of a kind sold or supplied by
          the Company and/or any Associated Company in respect of the sale or
          supply of which the Executive may have been engaged during his
          employment with the Company or any Associated Company:

          (i)    canvass, solicit or approach or cause to be canvassed,
                 solicited or approached for orders; or

          (ii)   directly or indirectly deal with

          any person, firm or company who at the date of the termination of this
          Agreement or within one year prior to such date is or was a customer
          of the Company or any Associated Company or was in the habit of
          dealing under contract with the Company or any Associated Company and
          with whom or which the Executive had contact during the said period;
          and

     (c)  for a period of 12 months after the termination of his employment
          hereunder either on his own behalf or on behalf of any other person,
          firm or company:

          (i)    directly or indirectly solicit or entice or endeavour to
                 solicit or entice away from the Company or from any Associated
                 Company any employee of executive or managerial status engaged
                 in its or their business and with whom the Executive had
                 dealings at any time during the last year of his employment
                 hereunder; and

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          (ii)   interfere or seek to interfere with the continuance of supplies
                 to the Company and/or any Associated Company (or the terms
                 relating to such supplies) from any suppliers who have been
                 supplying goods, materials or services to the Company and/or
                 any Associated Company at any time during the last year of his
                 employment hereunder.

     Whilst each of the restrictions in clauses 12.1(a), 12.1(b) and 12.1(c) are
     considered by the parties to be reasonable in all the circumstances as at
     the date hereof it is hereby agreed and declared that if any one or more of
     such restrictions shall be judged to be void as going beyond what is
     reasonable in all the circumstances for the protection of the interests of
     the Company and/or any Associated Company but would be valid if words were
     deleted therefrom the said restrictions shall be deemed to apply with such
     modifications as may be necessary to make them valid and effective and any
     such modification shall not thereby affect the validity of any other
     restriction contained herein.

13.  Payment on Termination

13.1 Either party may terminate this Agreement in accordance with clause 1.1.

13.2 If the Company terminates this Agreement on or after 4 January 2001
     (otherwise than by giving notice under clause 1.1 or pursuant to clause
     14), the Company will:

     (a)  pay to the Executive within 21 days after the termination of this
          Agreement a single lump sum (less all tax and other deductions
          required by law) equal to the aggregate of:

          (i)    the Executive's basic annual salary at the date of termination;

          (ii)   the annual premium payable by the Company to provide the
                 benefits in clause 4.2 above;

          (iii)  the annual value to the Executive of the Company car provided
                 to him under clause 6 above calculated by the Company in
                 accordance with the Automobile Association's tables current at
                 the date of termination.

     (b)  make a payment to the schemes referred to in clause 4.1 for the
          benefit of the Executive of an amount (subject to Inland Revenue
          limits) such that on retirement the Executive will be entitled to the
          same benefits to which he would have been entitled had he remained an
          employee of the Company for a further year.

13.3 If the Company terminates this Agreement before 4 January 2001 (other than
     by giving notice under clause 1.1 or pursuant to clause 14), the Company
     shall make a payment of half the amount referred to in clause 13.2(a),
     together with payment to the schemes referred to in clause 4.1 for the
     benefit of the Executive of an amount (subject to Inland Revenue limits)

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     such that on retirement the Executive will be entitled to the same benefits
     to which he would have been entitled had he remained an employee of the
     Company for a further six months.

13.4 The payments made under this clause will be in full and final settlement of
     all and any claims which the Executive has or may have against the Company
     in respect of the Executive's employment hereunder or the termination
     thereof.

14.  Termination on the happening of certain events

     The Company without prejudice to any remedy which it may have against the
     Executive for the breach or non-performance of any of the provisions of
     this Agreement may forthwith terminate this Agreement without notice or
     payment in lieu of notice if the Executive shall:

     (a)  become bankrupt or become the subject of an interim order under the
          Insolvency Act 1986 or make any arrangement or composition with his
          creditors; or

     (b)  become a patient as defined in the Mental Health Act 1983; or

     (c)  be convicted of any criminal offence (other than an offence under road
          traffic legislation in the United Kingdom or elsewhere for which a
          penalty other than imprisonment for three months or more is imposed);
          or

     (d)  commit any act of dishonesty whether relating to the Company, any
          Associated Company, other employees or otherwise; or

     (e)  be prevented by illness or otherwise from performing his duties
          hereunder for a consecutive period of six calendar months or for an
          aggregate period of six calendar months in any period of 12 calendar
          months; or

     (f)  be guilty of any serious misconduct, any conduct tending to bring the
          Company or himself into disrepute, or any material breach or non-
          observance of any of the provisions of this Agreement or shall
          neglect, fail or refuse to carry out duties properly assigned to him
          hereunder.

     On the termination of the Executive's employment, the Company shall pay to
     the Executive all amounts which are accrued and due to him as at the date
     thereof.

15.  Obligations upon termination of employment

     Upon the termination of his employment hereunder for whatever reason the
Executive shall:

     (a)  forthwith tender his resignation as a Director of the Company and of
          any Associated Company without compensation.  To secure his obligation
          under this Agreement the Executive irrevocably appoints the Company to
          be his attorney in his name and on his behalf to sign any documents
          and do any things necessary to give effect thereto, if the Executive
          shall fail to sign or do the same himself;

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<PAGE>

     (b)  deliver up to the Company all vehicles, keys, credit cards,
          correspondence, documents, specifications, reports, papers and records
          (including any computer materials such as discs or tapes) and all
          copies thereof and any other property (whether or not similar to the
          foregoing or any of them) belonging to the Company or any Associated
          Company which may be in his possession or under his control, and
          (unless prevented by the owner thereof) any such property belonging to
          others which may be in his possession or under his control and which
          relates in any way to the business or affairs of the Company or any
          Associated Company or any supplier, agent, distributor or customer of
          the Company or any Associated Company, and he shall not without
          written consent of the Board retain any copies thereof;

     (c)  if so requested send to the Company Secretary a signed statement
          confirming that he has complied with clause 15(b); and

     (d)  not at any time represent himself still to be connected with the
          Company or any Associated Company.

16.  Other terms and conditions

16.1 The provisions of the Company's standard terms and conditions of employment
     for management and administrative staff shall apply to the Executive's
     employment hereunder except so far as inconsistent herewith.

16.2 The following particulars are given in compliance with the requirements of
     s 1 Employment Rights Act 1996:

     (a)  the Executive's normal place of work is the Company's principal UK
          office from time to time but he may be required to work at any other
          office or location in the UK (or, with his consent, outside the UK) as
          may be directed by the Group Chief Executive or the Board from time to
          time;

     (b)  the Executive's continuous employment began on 4 January 2000.  No
          employment of the Executive with a previous employer counts as part of
          the Executive's continuous employment with the Company;

     (c)  the Executive's hours of work shall be the normal hours of work of the
          Company which are from 8.30 am to 5.00 pm Monday to Thursday and 8.30
          am to 4.30 pm on Fridays together with such additional hours as may be
          necessary for the proper discharge of his duties hereunder to the
          satisfaction of the Board;

     (d)  if the Executive is dissatisfied with any disciplinary decision or if
          he has any grievance relating to his employment hereunder he should
          refer such disciplinary decision or grievance to the Group Chief
          Executive and the reference will be dealt with by the Group Chief
          Executive;

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     (e)  a contracting-out certificate pursuant to the provisions of Pension
          Schemes Act 1993 is in force in respect of the Executive's employment
          hereunder; and

     (f)  save as otherwise herein provided there are no terms or conditions of
          employment relating to hours of work or to normal working hours or to
          entitlement to holiday (including public holidays) or holiday pay or
          to incapacity for work due to sickness or injury or to pensions or
          pension schemes or to requirements to work abroad and no collective
          agreement has any effect upon the Executive's employment hereunder.

17.  Definition

     In this Agreement an "Associated Company" means any company which for the
     time being is:

     (b)  a holding company (as defined by s 736 Companies Act 1985) of the
          Company; or

     (c)  any subsidiary (as defined by s 736 Companies Act 1985) of any such
          holding company or of the Company; or

     (d)  a company over which the Company has control within the meaning of s
          840 Income and Corporation Taxes Act 1988.

18.  Applicable law

     English law shall apply to this Agreement and the parties submit to the
     jurisdiction of the English Courts.

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                                  Schedule I


     Letter dated 15 December 1999 from the Company to the Executive is
attached.

                                      -11-
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IN WITNESS whereof this deed has been duly executed and delivered the day and
year first before written


Executed as a deed by         )
Raleigh Industries Limited    )
acting by                     )



------------------
Director



------------------
Director/Secretary



Signed as a deed by           )
Phillip Darnton               )
in the presence of:           )



------------------
Witness's name and signature



------------------
Witness's address

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