<PAGE>   1
                                                                    EXHIBIT 10.1


                              EMPLOYMENT AGREEMENT

        THIS EMPLOYMENT AGREEMENT (the "Agreement") is made as of this 3rd day
of August, 1998, between SHONEY's, INC., a Tennessee corporation, whose
principal place of business is located at 1727 Elm Hill Pike, Nashville,
Tennessee ("Employer"), and STEPHEN C. SANDERS, a resident of Madison, Tennessee
("Employee").

        1. TERM OF EMPLOYMENT.

           1.1 EMPLOYMENT. Employer hereby employs Employee, and Employee hereby
accepts employment with Employer, for the Employment Term (as hereinafter
defined).

           1.2 EMPLOYMENT TERM. The term of this Agreement and the Employment
Term shall commence on August 3, 1998, and terminate on August 2, 2001, unless
sooner terminated as herein provided or extended by a subsequent amendment or
extension of this Agreement executed by both parties hereto.

        2. DUTIES OF EMPLOYEE.

           2.1 GENERAL DUTIES. Employee is hereby employed as the President and
Chief Operating Officer of Shoney's Restaurants (the "Business Unit") with such
duties and responsibilities as the Chief Executive Officer of Employer or
Employer's Board of Directors shall designate, which shall be those duties and
responsibilities customarily prescribed for persons in the position of Employee.
Employee shall do and perform all services, acts, or things necessary or
advisable to manage and conduct the business of Employer, subject always to the
policies set forth by Employer's Board of Directors, in accordance with any and
all governing rules and regulations of regulatory agencies.

           2.2 DEVOTION OF ENTIRE TIME TO EMPLOYER'S BUSINESS. Employee will
devote his entire productive time, ability, and attention during normal business
hours to the business of Employer during the Employment Term. Employee shall
not, directly or indirectly, render any services of a business, commercial, or
professional nature to any other person or organization, whether for
compensation or otherwise, without the prior written consent of Employer's Board
of Directors; provided, however, that the foregoing shall not preclude
reasonable participation as a member in community, civic, or similar
organizations, or the pursuit of personal investments that neither interfere nor
conflict with his normal business activities for Employer; provided, further,
that Employer acknowledges and agrees that Employee has an ownership interest in
the food service 



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businesses identified on Exhibit A attached hereto and that he will retain such
interests during the Employment Term.

        3. COMPENSATION AND BENEFITS OF EMPLOYER.

           3.1 SALARY. As compensation for his services hereunder, Employee
shall receive a base salary (the "Base Salary"), which shall be payable in
accordance with the general payroll practices of Employer, and which during the
period from August 3, 1998 through December 31, 1999 shall be in an annual
amount (prorated as appropriate) of $300,000. During the remaining term of this
Agreement, Base Salary shall be in an amount determined by the Human Resources
and Compensation Committee of Employer's Board of Directors (the "Committee");
provided the Committee shall not decrease Employee's Base Salary for any period
within the Employment Term below $300,000 per annum.

           3.2 BONUSES. Employee shall be eligible for an annual bonus in an
amount equal to the Base Salary using performance criteria established by the
Board of Directors pursuant to the Shoney's, Inc. Annual Incentive Plan, as
amended from time to time. Up to fifty percent (50%) of the annual bonus may be
earned upon the achievement of the Business Unit objectives and up to fifty
percent (50%) may be earned upon the achievement of Employee's personal
performance objectives (objectives that are within the job description and
agreed to by Employee and the Chief Executive Officer of Employer). The Business
Unit objectives and personal performance objectives shall be established
annually and at all times are subject to review and approval of Employer's
Committee and/or the Board of Directors. Bonuses may be paid in cash or
Employer's $1.00 par value common stock.

           3.3 RESTRICTED STOCK.

               3.3.1 SHARES. Subject to all of the conditions (including, 
without limitation, the time of vesting and right to receive) and restrictions
set forth in this Section 3.3.1, Employer hereby grants to Employee an award of
75,000 shares (the "Restricted Shares") of Employer's $1.00 par value common
stock (the "Shares"). The Restricted Shares shall become vested in, and shall be
distributed to, Employee in three (3) installments on each of the dates set
forth below (each of which shall be referred to as a "Distribution Date," with
the three (3) dates being collectively referred to as the "Distribution Dates")
in the following respective amounts:

<TABLE>
<CAPTION>
               DISTRIBUTION DATE             NUMBER OF SHARES
               -----------------             ----------------
               <S>                           <C>   
                 August 2, 1999                   25,000
                 August 2, 2000                   25,000
                 August 2, 2001                   25,000
                                                  ------
                    Total                         75,000
                                                  ------
</TABLE>




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Immediately following each Distribution Date, Employer shall promptly cause its
transfer agent to issue a certificate to Employee evidencing the Restricted
Shares that became distributable. The issuance of any stock certificate to
Employee shall be subject to any applicable federal, state, or local tax
withholding requirements. If, prior to a Distribution Date, Employee's
employment is terminated, all rights of Employee in any Restricted Shares
awarded under this Section 3.3.1 that, as of the date of such termination, have
not become distributable to Employee shall thereupon immediately terminate and
become forfeited; provided, however, that if Employee's employment is terminated
pursuant to Section 4.1.1, Employee shall receive a pro-rata (based upon the
number of days worked by the Employee since the later of (i) the date of this
Agreement or (ii) the Distribution Date prior to the date of termination)
distribution of the Restricted Shares that would have otherwise become
distributable to him on the next succeeding Distribution Date.

         Employee shall not have any rights as a shareholder with respect to any
Restricted Shares until the issuance of a stock certificate evidencing the
Restricted Shares. The number of Restricted Shares awarded Employee under this
Section 3.3.1 shall be proportionately adjusted to reflect any stock dividend,
stock split or share combination of the Shares or any recapitalization of
Employer occurring prior to a Distribution Date. Except as provided in the
preceding sentence, no adjustment shall be made on the issuance of a stock
certificate to Employee as to any dividends or other rights for which the record
date occurred prior to a Distribution Date. The right of Employee to receive the
Restricted Shares shall not be assignable or transferable otherwise than by will
or the laws of descent and distribution.

         Upon receipt of Restricted Shares at a time when there is not in effect
under the Securities Act of 1933, as amended (the "Securities Act"), a current
registration statement relating to the Restricted Shares, Employee shall
represent and warrant in writing to Employer that the Restricted Shares are
being acquired for investment and not with a view to the distribution thereof
and shall agree to the placement of a legend on the certificate or certificates
representing the Restricted Shares evidencing the restrictions on transfer under
the Securities Act and the issuance of stop-transfer instructions by Employer to
its transfer agent with respect thereto.

         No Restricted Shares shall be issued hereunder unless and until the
then applicable requirements of the Securities Act, the Tennessee Business
Corporation Act, the Tennessee Securities Act of 1980, as any of the same may be
amended, the rules and regulations of the Securities and Exchange Commission and
any other regulatory agencies and laws having jurisdiction over or applicability
to Employer, and the rules and regulations of any securities exchange on which
the Shares may be listed, shall have been fully compiled with and satisfied.
Employer shall use its best efforts to cause all such requirements to be
promptly and completely satisfied. If, in the opinion of its counsel, the
issuance of any Shares hereunder shall not be lawful for any reason, including
the inability of Employer to obtain approval from any regulatory body having
jurisdiction or authority 



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deemed by such counsel to be necessary for such issuance, then Employer shall
not be obligated to issue any such Restricted Shares, but, in such event, shall
be obligated to provide Employee with cash or non-cash consideration having
equivalent after tax value which is acceptable to Employee in the exercise of
Employee's reasonable discretion.

               3.3.2 CASH COMPONENT. Upon the issuance of a certificate for any
Restricted Shares pursuant to Section 3.3.1, Employee shall be paid a cash bonus
by Employer which shall be in addition to any other bonus or bonuses provided
herein. The bonus payable pursuant to the preceding sentence shall be determined
by subtracting the Restricted Share Value (as defined below) from the Restricted
Share Gross Up (as defined below). "Restricted Share Value" shall mean the fair
market value of any Restricted Shares on the date that they become distributable
to Employee. "Restricted Share Gross Up" shall mean an amount equal to the
result derived by dividing: (a) the Restricted Share Value by (b) the Tax Factor
(as defined below). "Tax Factor" shall mean the greater of: (i) sixty-four
percent (64%); or (ii) the difference between one hundred percent (100%) and the
highest marginal individual income tax rate set forth in the Internal Revenue
Code of 1986, as amended, in the year in which Employee receives the portion of
the Restricted Shares with respect to which this bonus is being calculated.

           3.4 OPTIONS TO PURCHASE STOCK. Employee shall be granted, on the date
hereof, options to purchase 200,000 Shares with an exercise price equal to the
closing price of the Shares on the date hereof. Employee shall be granted, on
August 2, 1999, options to purchase an additional 200,000 Shares with an
exercise price equal to the greater of (1) the closing price of the Shares on
the grant date (August 2, 1999) or (2) the closing price of the Shares on the
date of this Agreement plus twenty percent (20%).

        Of the options granted pursuant to this Section 3.4, twenty percent
(20%) shall vest, on a cumulative basis, on each anniversary of each respective
grant and all such options that shall have vested shall be exercisable for a
period of 10 years from the date of grant. Except as the terms of such options
as set forth in this Section 3.4 may be inconsistent therewith, the terms and
conditions applicable to the options to be granted pursuant to this Section 3.4
shall otherwise be those contained in the Shoney's, Inc. 1981 Stock Option Plan,
as amended, the terms and conditions of which are incorporated herein by this
reference.

           3.5 LONG TERM INCENTIVE PLAN. Employee shall be eligible to
participate in the Shoney's, Inc. Executive Long Term Incentive Plan ("LTIP")
contingent upon the plan's approval by the Shoney's, Inc. Board of Directors,
the Human Resources and Compensation Committee and the Company's shareholders.

           3.6 MEDICAL BENEFITS. Employer shall provide Employee with medical
and dental insurance (which Employer may self insure) benefits in accordance
with the established 



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benefit policies of Employer are subject to any required premium contributions
for coverages elected by Employee.

           3.7  DISABILITY INSURANCE BENEFITS. Employer shall provide Employee
with disability insurance benefits in accordance with the established benefit
policies of Employer that provide disability insurance benefits to Employee in
an amount equal to fifty percent (50%) of base salary plus annual bonus target.

           3.8  LIFE INSURANCE. During the Employment Term, Employer shall
provide Employee, subject to satisfactory results of a physical examination,
with a renewable term life insurance policy in the amount of one million dollars
($1,000,000). The life insurance policy shall be owned by Employee and Employee
shall be entitled to designate the beneficiary thereof. In addition, Employee
shall be entitled to life insurance as provided pursuant to the Company's
benefit plans.

           3.9  EXPENSES. Employer shall reimburse Employee for all reasonable
and necessary business expenses of Employee incurred in the conduct of his
duties hereunder. Employee shall comply with all applicable policies of Employer
with respect to documentation and approval of such expenses.

           3.10 VACATIONS. Employee shall be entitled to an annual paid vacation
commensurate with Employer's established vacation policy for executive officers.
The timing of paid vacations shall be scheduled in a reasonable manner by
Employee.

           3.11 OTHER BENEFIT PROGRAMS. Employee shall be entitled to
participate in all employee benefit, bonus, and similar programs, including,
without limitation, programs of insurance, deferred compensation arrangements,
and all other benefits made available by Employer to senior management
personnel. During the Employment Term, so long as any additional benefit is made
available to senior management personnel of Employer, such benefit shall be
provided to Employee.

           3.12 LEGAL FEES, TAX PLANNING AND RETURNS AND FINANCIAL PLANNING.
Employer shall reimburse Employee for his reasonable legal expenses not in
excess of $5,000 in connection with the negotiation of this Agreement, and shall
provide annually to Employee an allowance for the preparation of his tax returns
and for tax and financial planning services in accordance with the established
policy of Employer.

       4.  TERMINATION OF EMPLOYMENT; SEVERANCE.



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           4.1 BY EMPLOYER.

               4.1.1  TERMINATION WITHOUT CAUSE. Employer's Chief Executive 
Officer or the Board of Directors may terminate Employee's employment, with or
without cause, at any time by giving written notice of such termination to
Employee, such termination of employment to be effective on a date specified in
such notice; provided, however, that in the event of such a termination without
cause, Employee shall be entitled to receive severance benefits in an amount
equal to the greater of (1) Employee's base pay as of the termination date for
the remainder of the term of employment or (2) severance benefits as provided
under the Shoney's, Inc. severance policy.

               4.1.2 TERMINATION FOR CAUSE. If Employee is terminated for cause,
Employer shall have no further obligation whatsoever to Employee hereunder (with
the exception of the obligation to pay Employee's Base Salary through the date
of termination of employment), and Employee's participation in all benefit
programs shall cease as of the date of termination. For purposes of this
Agreement, "cause" shall mean any one of the following:

         (i)      Employee's willful failure to carry-out any material lawful
                  duties assigned by Employer's Board of Directors which duties
                  are commensurate with those of similarly situated employees;

         (ii)     breach of fiduciary duty to Employer (or any of Employer's
                  subsidiaries) involving personal profit by Employee;

         (iii)    conviction of Employee for any crime involving the Employer's
                  business, or of a felony; or of any other crime resulting in
                  his imprisonment;

         (iv)     intentional breach by Employee of any material provision of 
                  this Agreement;

         (vi)     unsatisfactory performance by Employee of the duties
                  designated for Employee by Employer's Chief Executive Officer
                  or Board of Directors, if such unsatisfactory performance is a
                  result of alcohol or drug abuse by Employee; or

         (vii)    violation of Employer's policies.

                  4.2 TERMINATION BY EMPLOYEE. Employee may terminate his
employment with Employer at any time without further obligation whatsoever by
either party hereunder (with the exception of Employer's obligation to pay
Employee's Base Salary through the date of termination of employment and except
for the obligations and covenants of Employee pursuant 



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to Sections 5.1, 5.2 and 5.3, which shall survive termination as specified
therein) by giving not less than sixty (60) days' prior written notice of such
termination to Employer.

               4.3 EFFECT OF TERMINATION ON STOCK OPTIONS. In the event of any
termination of this Agreement and the Employment Term pursuant to Section 4.1.2
or Section 4.2, all stock options held by Employee that are vested prior to the
effective date of the termination shall be exercisable in accordance with their
terms, and all stock options held by Employee that are not vested prior to the
effective date of the termination shall lapse and be void. All stock options
granted to Employee shall provide (through amendment or otherwise) that, in the
event of any termination of Employee's employment pursuant to Section 4.1.1,
then, in addition to any other rights of Employee hereunder, all such options
shall become fully vested and shall be exercisable in accordance with their
respective terms upon such a termination for ninety (90) days immediately
following the date of termination.

         5.    COVENANT NOT TO COMPETE; NON-DISCLOSURE; NON-SOLICITATION.

               5.1 COVENANT NOT TO COMPETE. Employee acknowledges that
Employer's business is built upon the confidence of its customers, suppliers,
employees, and the general public, and that Employee will acquire confidential
knowledge that should not be divulged or used for his own benefit. Employee,
subject to the provisions of Section 2.2, covenants and agrees that during the
term hereof, he will not, without the prior written consent of Employer, engage
in, own, manage, operate, control, or participate in any food service business,
except to the extent provided on Exhibit A attached hereto.

               Employee understands and acknowledges that his violation of this
covenant not to compete is a material provision of this Agreement and would
cause irreparable harm to Employer.

               5.2 NON-DISCLOSURE OF INFORMATION. Employee recognizes and
acknowledges that, as a result of his employment by Employer, he will become
familiar with and acquire knowledge of confidential information and certain
trade secrets that are valuable, special, and unique assets of Employer.
Employee agrees that any such confidential information and trade secrets are the
property of Employer. Therefore, Employee agrees that, for and during the entire
Employment Term, any such confidential information and trade secrets shall be
considered to be proprietary to Employer and kept as the private records of
Employer and will not be divulged to any firm, individual, or institution except
pursuant to and within the course and scope of Employee's employment hereunder.
Further, upon termination of Employee's employment, the Employment Term and/or
this Agreement for any reason whatsoever, Employee agrees that he 



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will, for a period of three (3) years after such date, continue to treat as
private and proprietary to Employer any such confidential information and trade
secrets and will not, for a period of three (3) years after such date, release
any such confidential information and trade secrets to any person, firm, or
institution, or use them to the detriment of Employer. The parties agree that
nothing in this Agreement shall be construed as prohibiting Employer from
pursuing any remedies available to it for any breach or threatened breach of 
this Section 5.2, including, without limitation, the recovery of damages from
Employee or any person or entity acting in concert with Employee.

               5.3 NON-SOLICITATION. Employee recognizes and acknowledges that,
as a result of his employment by Employer, he will become familiar with and
acquire knowledge of confidential information and certain other information
regarding employees of Employer. Therefore, Employee agrees that, during the
term hereof, and for a period of two (2) years from the date of termination of
Employee's employment, the Employment Term and/or this Agreement, whichever is
later, Employee shall not encourage, solicit or otherwise attempt to persuade
any person in the employment of Employer to end his/her employment with
Employer. The parties agree that nothing in this Agreement shall be construed as
prohibiting Employer from pursuing any remedies available to it for any breach
or threatened breach of this Section 5.3, including, without limitation, the
recovery of damages from Employee or any person or entity acting in concert with
Employee. Employer shall receive injunctive relief without the necessity of
posting bond or other security, such bond or other security being hereby waived
by Employee.

         6.    DEATH OR DISABILITY OF EMPLOYEE.

               6.1 DEATH OF EMPLOYEE. In the event Employee dies during the
Employment Term, this Agreement and the Employment Term shall terminate upon
Employee's death. Employee's estate shall be entitled only to any Base Salary
earned but not paid plus any bonus accrued by Employer for Employee through the
date of death, plus an amount equal to the Base Salary and bonus paid or payable
on Employee's behalf for the twelve months of employment immediately prior to
the month in which Employee's death occurred. Such payment shall be paid in lump
sum to Employee's estate within ninety (90) days after Employee's death.

               6.2 DISABILITY OF EMPLOYEE. Employer has disability insurance
insuring its officers, and Employee is included under such disability insurance.
In the event of the Disability (as hereinafter defined) of Employee, this
Agreement and the Employment Term shall terminate. Upon a termination resulting
from the Disability of Employee, Employee shall be entitled to receive (i) any
Base Salary earned but not paid through the date that Employee becomes eligible
for disability payments under such disability insurance, and (ii) an amount
equal to the Base 



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Salary and bonus received by Employee in the last twelve months of employment
immediately prior to the month in which such Disability of Employee occurs which
amount shall be payable, at the option of Employee, in a lump sum payment or in
equal installments paid in accordance with the general payroll policies of
Employer over a period not to exceed three (3) years from the effective date of
termination due to the Disability of Employee; provided, however, that Employee
shall not be entitled to any payments under this Section 6.2 in the event this
Agreement is terminated pursuant to Section 4.1.2 regardless of whether the
"cause" for which this Agreement is terminated pursuant to Section 4.1.2 also
may constitute a Disability. For purposes of this Agreement, a "Disability" of
Employee shall occur if (i) Employee suffers any mental or physical condition
that, as determined pursuant to the terms of the Shoney's, Inc. Group Long Term
Disability Plan, materially impairs Employee's ability to perform the essential
functions of his duties hereunder and (ii) thereafter, Employee, within fifteen
(15) days after Employee receives written notice from Employer requesting that
Employee resume his duties hereunder, is unable or refuses to do so.

         7.       GENERAL PROVISIONS.

                  7.1 INDEMNIFICATION. Employer shall indemnify and hold
harmless Employee to the maximum extent permitted by Tennessee law with respect
to all claims, demands, actions, proceedings, investigations, damages, costs,
and expenses (including without limitation reasonable attorneys' fees) by reason
of the fact that he is or was a director or officer of Employer or any of its
subsidiaries. Further, Employer shall, to the maximum extent permitted by
Tennessee law, pay any and all expenses (including without limitation reasonable
attorneys' fees and disbursements, court costs and expert witness fees) incurred
by Employee in defending any claim, demand, action, proceeding or investigation
arising by reason of the fact that Employee is or was an officer or director of
Employer or any of its subsidiaries. In the event it is necessary for the
Employer or its shareholders to take any action in order for Employee to receive
the maximum benefit of this provision, the Employer will make a good faith
effort to take such action and to secure the approval of its shareholders, in
the event such approval is required.

                  7.2 NO MITIGATION. Except as expressly provided to the
contrary herein, Employee shall not be required to mitigate damages or the
amount of any payment provided for under this Agreement by seeking other
employment or otherwise, nor shall the amount of any payment provided for under
this Agreement be reduced by any compensation earned by Employee as a result of
employment by another employer after Employee's termination or resignation.



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                  7.3 NOTICES. Any notices to be given hereunder by either party
to the other may be effected by personal delivery in writing or by mail,
registered or certified, postage prepaid with return receipt requested. Mailed
notices shall be addressed to the parties at the addresses appearing in the
introductory paragraph of this Agreement (to the attention of the Secretary in
the case of notices to Employer), but each party may change such address by
written notice in accordance with this Section 7.3. Notices delivered personally
shall be deemed communicated at the time of actual receipt; mailed notices shall
be deemed communicated as of the third day following deposit in the United
States Mail.

                  7.4 ENTIRE AGREEMENT. This Agreement supersedes any and all
other agreements, either oral or in writing, between the parties hereto with
respect to the employment of Employee by Employer and contains all of the
covenants and agreements between the parties with respect to such employment in
any manner whatsoever. Each party to this Agreement acknowledges that no
representations, inducements, promises, or agreements, orally or otherwise, have
been made by any party, or anyone acting on behalf of any party, which are not
embodied herein and that no other agreement shall be valid or binding unless in
writing and signed by the party against whom enforcement of such agreement is
sought. Any modification of this Agreement will be effective only if it is in
writing signed by the party against whom enforcement of such modification is
sought.

                  7.5 PARTIAL INVALIDITY. If any provision in this Agreement is
held by a court of competent jurisdiction to be invalid, void, or unenforceable,
the remaining provisions shall nevertheless continue in full force without being
impaired or invalidated in any way.

                  7.6 LAW GOVERNING AGREEMENT. This Agreement shall be governed 
by and construed in accordance with the laws of the State of Tennessee.

                  7.7 WAIVER OF JURY TRIAL. Employer and Employee hereby
expressly waive any right to a trial by jury in any action or proceeding to
enforce or defend any rights under this Agreement, and agree that any such
action or proceeding shall be tried before a court and not a jury. Employee and
Employer hereby agree that any action or proceeding to enforce any claim arising
out of this Agreement shall be brought and maintained in any state or federal
court having subject matter jurisdiction and located in Nashville, Tennessee.
Employee irrevocably waives, to the fullest extent permitted by law, any
objection that he may have or hereafter have to the laying of the venue of any
such action or proceeding brought in any court located in Nashville, Tennessee,
and any claim that any such action or proceeding brought in such a court has
been brought in an inconvenient forum.



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                  7.8 MISCELLANEOUS. Failure or delay of either party to insist
upon compliance with any provision hereof will not operate as and is not to be
construed to be a waiver or amendment of the provision or the right of the
aggrieved party to insist upon compliance with such provision or to take
remedial steps to recover damages or other relief for noncompliance. Any express
waiver of any provision of this Agreement will not operate and is not to be
construed as a waiver of any subsequent breach, irrespective of whether
occurring under similar or dissimilar circumstances. Employee acknowledges and
represents that the services to be rendered by him are unique and personal.
Accordingly, Employee may not assign any of his rights or delegate any of his
duties or obligations under this Agreement. The rights and obligations of
Employer under this Agreement shall inure to the benefit of and shall be binding
upon the successors and assigns of Employer.

                  [THIS SPACE LEFT BLANK INTENTIONALLY]




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         IN WITNESS WHEREOF, Employee has hereunto affixed his hand and Employer
has caused this Agreement to be executed by its duly authorized officer as of
the day and year first above written.

         EMPLOYEE:                         EMPLOYER:
         ---------                         ---------
         /s/ Stephen C. Sanders
         -------------------------         SHONEY's, INC.

         Stephen C. Sanders

                                      By:  /s/ F. E. McDaniel, Jr.
                                           -------------------------------------
                                           Name: F. E. McDaniel, Jr.
                                           Title: Chief Administrative Officer



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