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                                                                   EXHIBIT 10.15



                            KRAUSE'S FURNITURE, INC.

                      SERIES A CONVERTIBLE PREFERRED STOCK

                          SECURITIES PURCHASE AGREEMENT


                          Dated as of January 11, 2000




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                                 TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                PAGE
<S>     <C>                                                                     <C>
1.      PURCHASE AND SALE OF THE SERIES A PREFERRED STOCK.......................  1

1.1.    Authorization to Sell the Series A Preferred Stock......................  1
1.2.    Closings................................................................  1
1.3.    Deliveries at Closings..................................................  2
1.4.    Restructuring of Certain Indebtedness...................................  3
1.5.    Definitions.............................................................  3

2.      REPRESENTATIONS AND WARRANTIES OF THE COMPANY...........................  3

2.1.    Organization and Qualification..........................................  3
2.2.    Due Authorization.......................................................  3
2.3.    Subsidiaries............................................................  4
2.4.    SEC Reports.............................................................  4
2.5.    Financial Statements....................................................  4
2.6.    Actions Pending; Compliance with Laws...................................  5
2.7.    Title to Properties; Insurance..........................................  5
2.8.    Governmental Consents, etc..............................................  6
2.9.    Holding Company Act and Investment Company Act..........................  6
2.10.   Taxes...................................................................  6
2.11.   Conflicting Agreements and Charter Provisions...........................  7
2.12.   Capitalization..........................................................  7
2.13.   Issuance, Sale and Delivery of the Series A Preferred Stock.............  8
2.14.   Registration Under Exchange Act.........................................  8
2.15.   ERISA...................................................................  9
2.16.   Possession of Franchises, Licenses, etc.................................  9
2.17.   Environmental and Other Regulations..................................... 10
2.18.   Patents and Trademarks.................................................. 10
2.19.   Material Contracts and Obligations...................................... 10
2.20.   Books and Records....................................................... 11
2.21.   Transactions with Related Parties....................................... 11
2.22.   Brokers................................................................. 11
2.23.   Accuracy of Information................................................. 11
2.24.   Offering of Series A Preferred Stock.................................... 12
</TABLE>

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<TABLE>
<S>     <C>                                                                     <C>
3.      REPRESENTATIONS AND WARRANTIES OF THE PURCHASERS........................ 12

3.1.    Organization and Qualification.......................................... 12
3.2.    Due Authorization....................................................... 12
3.3.    Conflicting Agreements and Other Matters................................ 13
3.4.    Acquisition for Investment.............................................. 13
3.5.    Brokers or Finders...................................................... 13
3.6.    Accredited Investor..................................................... 13

4.      COVENANTS OF THE COMPANY................................................ 13

4.1.    Limitation on Senior Equity Securities ................................. 14
4.2.    Compliance with Laws.................................................... 14
4.3.    Preservation of Franchises and Existence................................ 14
4.4.    Use of Proceeds......................................................... 14
4.5.    Insurance............................................................... 14
4.6.    Payment of Taxes and Other Charges...................................... 14
4.7.    Effect of Breach........................................................ 15
4.8.    ERISA................................................................... 15
4.9.    Financial Statements and Other Reports.................................. 16
4.10.   Inspection of Property.................................................. 17
4.11.   Lost, Stolen, Damaged and Destroyed Stock Certificates.................. 18
4.12.   Related Party Transactions.............................................. 18
4.13.   Operations in Accordance with Business Plan............................. 18
4.14.   Reservation of Shares................................................... 18
4.15.   Notice of Breach........................................................ 19
4.16.   Limitation on Dividends ................................................ 19
4.17    Right of First Refusal.................................................. 19

5.      RESTRICTIONS ON TRANSFER................................................ 20

6.      EVENT OF DEFAULT AND REMEDIES........................................... 20

6.1.    Event of Default........................................................ 21
6.2.    Remedies................................................................ 21
6.3.    Conduct no Waiver....................................................... 21
6.4     Remedies Cumulative..................................................... 22
</TABLE>



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<TABLE>
<S>     <C>                                                                     <C>
7.      CONDITIONS.............................................................. 22

7.1     Conditions to Each Party's Obligations to Effect the Transactions
        Contemplated Hereby..................................................... 22
7.2     Conditions to Purchasers' Obligations to Effect the Transactions
        Contemplated Hereby..................................................... 23

8.      INTERPRETATION.......................................................... 24

8.1.    Definitions............................................................. 24
8.2.    Accounting Principles................................................... 27

9.      MISCELLANEOUS........................................................... 27

9.1.    Severability............................................................ 27
9.2.    Specific Enforcement.................................................... 28
9.3.    Entire Agreement........................................................ 28
9.4.    Counterparts............................................................ 28
9.5.    Notices and Other Communications........................................ 28
9.6.    Amendments.............................................................. 29
9.7.    Cooperation............................................................. 30
9.8.    Successors and Assigns.................................................. 30
9.9.    Expenses and Remedies................................................... 30
9.10.   Survival of Representations and Warranties.............................. 32
9.11.   Transfer of Series A Preferred Stock.................................... 32
9.12.   Governing Law; Consent to Jurisdiction.................................. 33
9.13.   Publicity............................................................... 34
9.14.   Signatures.............................................................. 34
</TABLE>


Exhibit A - Form of Amended and Restated Stockholders' Agreement
Exhibit B - Form of Opinion of Morrison & Foerster LLP
Exhibit C - Form of Amended and Restated Registration Rights Agreement
Exhibit D - Form of Indebtedness Amendment



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        This Securities Purchase Agreement, dated as of January 11, 2000 (this
"Agreement"), between Krause's Furniture, Inc., a Delaware corporation
(including its predecessors, the "Company") and the purchasers listed on the
signature pages hereto (each a "Purchaser", and collectively, the "Purchasers").

        WHEREAS, the Purchasers wish to severally purchase from the Company, and
the Company wishes to sell to the Purchasers, an aggregate of 380,000 shares of
the Company's Series A Convertible Preferred Stock, par value $.001 per share
(the "Series A Preferred Stock"), at an aggregate purchase price of $19,000,000.

        WHEREAS, in connection with the purchase and sale of the Series A
Preferred Stock, the Purchasers, the Company and the stockholders listed on the
signature pages thereof, will enter into an amended and restated Stockholders
Agreement, substantially in the form attached hereto as Exhibit A (the
"Stockholders Agreement").

        WHEREAS, the Purchasers and the Company desire to provide for such
purchase and sale and to establish various rights and obligations in connection
therewith.

        NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements herein set forth, the parties hereto agree as follows:

        SECTION 1. PURCHASE AND SALE OF THE SERIES A PREFERRED STOCK.

        1.1 Authorization to Sell the Series A Preferred Stock. Subject to the
terms and conditions of this Agreement, the Company has duly authorized the
issuance and sale of the Series A Preferred Stock.

        1.2 Closings. The transactions contemplated hereby will take place in
two closings. The first closing shall be held on or prior to January 18, 2000
(the "First Closing") at the offices of Skadden, Arps, Slate, Meagher & Flom LLP
("SASM&F"), 300 South Grand Avenue, Suite 3400, Los Angeles, California 90071-
3144 at 9:00 a.m., or at such place, date and time as shall be mutually agreed
by the Company and the Initial Purchasers (the "First Closing Date"). The second
closing shall be held on or prior to January 18, 2000 (the "Second Closing" and
together with the First Closing, the "Closings") at SASM&F, 300 South Grand
Avenue, Los Angeles, California 90071-3144, at 9:00 a.m, or such place, date and
time as shall be

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mutually agreed by the Company and the Individual Purchasers (the "Second
Closing Date" and together with the First Closing Date, the "Closing Dates").

        1.3 Deliveries at Closings.

               (a)  At the First Closing:

               (i)  the Company shall execute and deliver an Amended and
        Restated Stockholders Agreement in the form of Exhibit A hereto;

               (ii) Morrison & Foerster LLP, counsel to the Company, shall
        deliver to the Initial Purchasers an opinion dated the First Closing
        Date substantially in the form of Exhibit B hereto;

               (iii) the Company shall execute and deliver an Amended and
        Restated Registration Rights Agreement substantially in the form of
        Exhibit C hereto (the "Registration Rights Agreement");

               (iv) the Company shall deliver to each Initial Purchaser stock
        certificates representing the number of shares of Series A Preferred
        Stock to be purchased by such Initial Purchaser, as set forth under its
        signature on the signature pages hereto, registered in the name of such
        Initial Purchaser or its designee or nominee;

               (v) each Initial Purchaser shall pay to the Company, by wire
        transfer of immediately available funds, the purchase price for the
        Series A Preferred Stock being purchased by such Initial Purchaser; and

               (vi) the Company shall deliver evidence of the restructuring of
        certain indebtedness of the Company as described in Section 1.4 below in
        form and substance satisfactory to the Initial Purchasers.

               (b) At the Second Closing:

               (i) Morrison & Foerster LLP, counsel to the Company, shall
        deliver to the Individual Purchasers an opinion dated the Second Closing
        Date substantially in the form of Exhibit B hereto;


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               (ii) the Company shall deliver to each Individual Purchaser stock
        certificates representing the number of shares of Series A Preferred
        Stock to be purchased by such Individual Purchaser, as set forth under
        its signature on the signature pages hereto, registered in the name of
        such Individual Purchaser or its designee or nominee; and

               (iii) each Individual Purchaser shall pay to the Company, by wire
        transfer of immediately available funds, the purchase price for the
        Series A Preferred Stock being purchased by such Individual Purchaser.

        1.4 Restructuring of Certain Indebtedness. On or before the First
Closing Date, the Company shall execute and deliver an Amendment to the Note
Agreement substantially in the form of Exhibit D hereto (the "Indebtedness
Amendment").

        1.5 Definitions. Certain capitalized terms used in this Agreement are
defined in Section 8 hereof.

        SECTION 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY.

        The Company represents and warrants as follows:

        2.1 Organization and Qualification. Each of the Company and its
Subsidiaries is a corporation duly organized and existing in good standing under
the laws of the jurisdiction in which it is incorporated and has the power to
own its respective property and to carry on its respective business as now being
conducted. Each of the Company and its Subsidiaries is duly qualified as a
foreign corporation to do business and in good standing in every jurisdiction in
which the nature of the respective business conducted or property owned by it
makes such qualification necessary and where the failure so to qualify would be
material to the Company or such Subsidiary, as the case may be.

        2.2 Due Authorization. The execution and delivery of this Agreement, the
Stockholders Agreement and the Registration Rights Agreement, and the issuance
and sale of the Series A Preferred Stock by the Company and compliance by the
Company with all the provisions of this Agreement, the Stockholders Agreement
and the Registration Rights Agreement (i) are within the corporate power and
authority of the Company; (ii) do not and will not require any approval or
consent of the stockholders of the Company or any other Person, other than
approvals and consents which have been duly obtained or which will be obtained
pursuant to Section 4.14;

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and (iii) have been authorized by all requisite corporate proceedings on the
part of the Company. This Agreement, the Stockholders Agreement and the
Registration Rights Agreement have been duly executed and delivered by the
Company and constitute valid and binding agreements of the Company, enforceable
in accordance with their respective terms, except that (i) such enforcement may
be subject to bankruptcy, insolvency, reorganization, moratorium or other
similar laws now or hereafter in effect relating to creditors' rights, and (ii)
the remedy of specific performance and injunctive and other forms of equitable
relief may be subject to equitable defenses and to the discretion of the court
before which any proceeding therefor may be brought. The Company has furnished
to the Purchasers true and correct copies of the Company's Certificate of
Incorporation and By-laws as in effect on the date of this Agreement.

        2.3 Subsidiaries. The Subsidiaries of the Company, all of which are
wholly owned by the Company, together with their jurisdiction of incorporation,
are as set forth on Schedule 2.3 hereto.

        2.4 SEC Reports. The Company and its predecessor have filed all proxy
statements, reports and other documents required to be filed by it under the
Exchange Act, since December 31, 1996; and the Company has furnished the
Purchasers copies of its Annual Report on Form 10-K for the fiscal year ended
January 31, 1999, and all proxy statements and reports under the Exchange Act
filed by the Company after such date, each as filed with the Securities and
Exchange Commission (the "Commission") (collectively, the "SEC Reports"). Each
SEC Report was in compliance in all material respects with the requirements of
its respective report form and did not on the date of filing contain any untrue
statement of a material fact or omit to state a material fact required to be
stated therein or necessary to make the statements therein, in the light of the
circumstances under which they were made, not misleading. As of the date hereof
there is no fact not disclosed in the SEC Reports which is material to the
Company.

        2.5 Financial Statements. The financial statements (including any
related schedules and/or notes) included in the SEC Reports have been prepared
in accordance with generally accepted accounting principles consistently
followed (except as indicated in the notes thereto) throughout the periods
involved and fairly present the consolidated financial condition, results of
operations, changes in stockholders' equity and cash flows of the Company and
its Subsidiaries as of the dates thereof and for the periods ended on such dates
(in each case subject, as to interim statements, to changes resulting from
year-end adjustments, which in the aggregate will not be

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material in amount or effect). The Company and its Subsidiaries have no material
liabilities, contingent or otherwise, not reflected in the Company's balance
sheet as of January 31, 1999 that is included in the SEC Reports or otherwise
referred to in the SEC Reports or otherwise disclosed to the Purchasers in
writing prior to the date of this Agreement, other than any such liabilities
incurred in the ordinary course of business, consistent with past practice,
since January 31, 1999. Since January 31, 1999, the Company and its Subsidiaries
have operated their respective businesses only in the ordinary course,
consistent with past practice, and no event has occurred that has or is
reasonably likely to have a material adverse effect on the business, financial
condition, operations, results of operations, assets, liabilities or prospects
of the Company or any of its Subsidiaries (a "Material Adverse Effect"), other
than changes disclosed or referred to in the SEC Reports or otherwise disclosed
to the Purchasers in writing prior to the date of this Agreement.

        2.6 Actions Pending; Compliance with Laws. There is no action, suit,
investigation or proceeding pending or, to the knowledge of the Company,
threatened by any public official or governmental authority, against the Company
or any of its Subsidiaries or any of their respective properties or assets by or
before any court, arbitrator or governmental body, department, commission,
board, bureau, agency or instrumentality, which questions the validity or
enforceability of, or seeks to enjoin or invalidate this Agreement, the
Stockholders Agreement, the Registration Rights Agreement or the Series A
Preferred Stock or any action taken or to be taken pursuant hereto or thereto,
or, except as set forth in the SEC Reports or as otherwise disclosed to the
Purchasers in writing, which is reasonably likely to be material to the Company
or any of its Subsidiaries, and neither the Company nor any of its Subsidiaries
is in default in any material respect with respect to any judgment, order, writ,
injunction, decree or award.

        2.7 Title to Properties; Insurance. The Company and each of its
Subsidiaries have good and valid title to, or, in the case of property leased by
any of them as lessee, a valid and subsisting leasehold interest in, their
respective properties and assets, free of all liens and encumbrances other than
those referred to in the financial statements of the Company (or the notes
thereto) for the fiscal year ended January 31, 1999, included in the SEC
Reports, except in each case for such defects in title and such other liens and
encumbrances which are disclosed in the SEC Reports or which do not in the
aggregate materially detract from the value to the Company and its Subsidiaries
of their respective properties and assets. The Company and its Subsidiaries
maintain insurance in such amounts (to the extent available in the public
market), including self-insurance, retainage and deductible arrangements, and of
such

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a character as is reasonable for companies engaged in the same or similar
business. All insurance policies of the Company and its Subsidiaries are
disclosed on Schedule 2.7.

        2.8 Governmental Consents, etc. The Company is not required to obtain
any consent, approval or authorization of, or to make any declaration or filing
with, any governmental authority or other Person as a condition to or in
connection with the valid execution, delivery and performance of this Agreement,
the Stockholders Agreement and the Registration Rights Agreement and the valid
offer, issue, sale or delivery of the Series A Preferred Stock, or the
performance by the Company of its obligations in respect thereof, except for any
filings required to effect any registration pursuant to the Registration Rights
Agreement and any filings required pursuant to state and federal securities laws
which will be timely made after the applicable Closing hereunder.

        2.9 Holding Company Act and Investment Company Act. Neither the Company
nor any Subsidiary is: (i) a "public utility company" or a "holding company," or
an "affiliate" or a "subsidiary company" of a "holding company," or an
"affiliate" of such a "subsidiary company," as such terms are defined in the
Public Utility Holding Company Act of 1935, as amended, or (ii) a "public
utility," as defined in the Federal Power Act, as amended, or (iii) an
"investment company" or an "affiliated person" thereof or an "affiliated person"
of any such "affiliated person," as such terms are defined in the Investment
Company Act of 1940, as amended.

        2.10 Taxes. (a) The Company and each of its Subsidiaries have filed or
caused to be filed all tax returns which are required to be filed by them, and
all such tax returns are true, complete and correct in all material respects.
The Company and each of its Subsidiaries have paid or caused to be paid all
taxes that have become due, except taxes the validity or amount of which is
being contested in good faith by appropriate proceedings and with respect to
which adequate reserves have been set aside in accordance with generally
accepted accounting principles. The federal income tax returns of the Company
and its Subsidiaries have been examined and reported on by the Internal Revenue
Service (or closed by applicable statutes) and all tax liabilities including
additional assessments have been satisfied for all fiscal years prior to and
including the fiscal year ended December 31, 1993 for the Company and its
Subsidiaries. The Company and its Subsidiaries have paid or caused to be paid,
or have established reserves in accordance with generally accepted accounting
principles that the Company reasonably believes are adequate, for all federal
income tax liabilities and state income tax liabilities applicable to the
Company or any of its

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Subsidiaries for all fiscal years which have not been examined and reported on
by the taxing authorities (or closed by applicable statutes).

               (b) As of January 31, 1999, the Company did not have any
accumulated "earnings and profits" as determined under section 312 of the
Internal Revenue Code of 1986, as amended (the "Code"). To the best knowledge
and belief of the Company, the Company does not anticipate having any material
current earnings and profits, as determined under section 312 of the Code, for
its current taxable year. As of the date hereof, the Company is not a "United
States real property holding corporation" within the meaning of section
897(c)(2) of the Code. The Company shall not become a United States real
property holding corporation.

        2.11 Conflicting Agreements and Charter Provisions. Neither the Company
nor any of its Subsidiaries is a party to any contract or agreement or subject
to any charter or bylaw provision or judgment or decree which has or is
reasonably likely to have a Material Adverse Effect. None of (i) the execution
and delivery of this Agreement, the Shareholders Agreement and the Registration
Rights Agreement and the issuance of the Series A Preferred Stock and (ii) the
fulfillment of and compliance with the terms and provisions hereof and thereof
and of the Series A Preferred Stock will conflict with or result in a breach of
the terms, conditions or provisions of, or give rise to a right of termination
under, or constitute a default under, or result in any violation of, the
Certificate of Incorporation or By-laws of the Company or any Subsidiary or any
mortgage, agreement, instrument, order, judgment, decree, statute, law, rule or
regulation to which the Company or any Subsidiary or any of their respective
properties is subject. Neither the Company nor any of its Subsidiaries (i) is in
default under any outstanding indenture or other debt instrument or with respect
to the payment of principal of or interest on any outstanding obligation for
borrowed money, or (ii) is in default under any of their respective contracts or
agreements, or under any instrument by which the Company or any of its
Subsidiaries is bound which default, in the case of this clause (ii),
individually or in the aggregate with all other such defaults, would be material
to the Company or any of its Subsidiaries.

        2.12 Capitalization. As of the date hereof, the authorized capital stock
of the Company consists of: (a) 35,000,000 shares of Common Stock, par value
$0.001 per share (the "Common Stock" and, together with the Series A Preferred
Stock, the "Stock"), of which 22,050,328 shares are validly issued and
outstanding, fully paid and nonassessable; (b) warrants to purchase 2,712,045
shares of Common Stock which are validly issued and outstanding, fully paid and
nonassessable; (c) options to

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purchase 2,823,458 shares of Common Stock and deferred stock units representing
the right to receive 85,225 shares of Common Stock, all of which are validly
issued and outstanding, fully paid and nonassessable; and (d) 666,667 shares of
Preferred Stock, par value $.001 per share, of which no shares are outstanding,
as of the date hereof, and 380,000 shares designated as Series A Convertible
Preferred Stock will be issued and outstanding on the Second Closing Date after
consummation of the transactions contemplated hereby. All of the outstanding
shares of Common Stock have been validly issued and are fully paid and
nonassessable. Except as set forth in the Stockholders Agreement, no class of
capital stock of the Company is entitled to preemptive rights. Except for the
options and warrants listed above, there are no outstanding options, warrants,
scrip, rights to subscribe to, calls or commitments of any character whatsoever
relating to, securities or rights convertible into, shares of any class of
capital stock of the Company, or contracts, commitments, understandings, or
arrangements by which the Company is or may become bound to issue additional
shares of its capital stock or options, warrants or rights to purchase or
acquire any shares of its capital stock. Since August 1, 1996, the Company has
not changed the amount of its authorized capital stock or subdivided or
otherwise changed any shares of any class of its capital stock, whether by way
of reclassification, recapitalization, stock split or otherwise, or issued or
reissued, or agreed to issue or reissue, any of its capital stock.

        2.13 Issuance, Sale and Delivery of the Series A Preferred Stock. The
shares of Series A Preferred Stock being issued to the Initial Purchasers at the
First Closing and the shares of Series A Preferred Stock being issued to the
Individual Purchasers at the Second Closing are duly authorized and when issued
and delivered in accordance herewith will be, validly issued, fully paid and
nonassessable. The 17,272,727 shares of Common Stock to be issued upon
conversion of the Series A Preferred Stock, when issued and delivered upon such
conversion in accordance with the terms of the Certificate of Designation, will
be validly issued, fully paid and nonassessable. The Company will take all
action necessary to increase its authorized but unissued shares of Common Stock
to such number of shares as shall be sufficient to reserve shares of Common
Stock for issuance upon conversion of the Series A Preferred Stock, including,
without limitation, obtaining the requisite stockholder approval of any
necessary amendment to the Company's Certificate of Incorporation.

        2.14 Registration Under Exchange Act. The Company has not registered the
Series A Preferred Stock as a class pursuant to Section 12 of the Exchange Act.


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        2.15 ERISA. No accumulated funding deficiency (as defined in Section 302
of ERISA and Section 412 of the Code), whether or not waived, exists with
respect to any Pension Plan (as defined in Section 11) (other than a
Multiemployer Plan (as defined below)). No liability to the PBGC has been, or is
reasonably likely to be, incurred with respect to any Pension Plan (other than a
Multiemployer Plan) by the Company, any of its Subsidiaries or any ERISA
Affiliate (as defined below) which is or would be materially adverse to the
Company, its Subsidiaries and any ERISA Affiliate. Neither the Company nor any
of its Subsidiaries and any ERISA Affiliate has incurred, or is reasonably
likely to incur, any withdrawal liability under Title IV of ERISA with respect
to any Multiemployer Plan which is or would be materially adverse to the
Company, its Subsidiaries and its ERISA Affiliates and if the Company, its
Subsidiaries and ERISA Affiliates, were to completely withdraw as of the date
hereof from each Multiemployer Plan in which they participate, the Company, its
Subsidiaries and its ERISA Affiliates would not incur any material withdrawal
liability under Title IV of ERISA. Neither the Company nor any of its
Subsidiaries has any obligation to provide post-retirement health benefits to
any employee or former employee. No fiduciary of any employee benefit plan (as
defined in Section 3(3) of ERISA) maintained or contributed to by the Company or
any of its subsidiaries, for the benefit of their respective employees (each an
"Employee Plan") has engaged or caused any Employee Plan to engage in any
transaction prohibited by Section 4975 of the Code or Section 406 of ERISA which
is reason ably likely to subject the Company or any Subsidiary or any entity the
Company or any Subsidiary has an obligation to indemnify to any tax or penalty
imposed under Section 4975 of the Code or Section 502 of ERISA. Each Employee
Plan has been maintained and administered in compliance with all applicable law
including ERISA and the Code in all material respects. An "ERISA Affiliate" for
purposes of this Section is any trade or business, whether or not incorporated,
which, together with the Company, is under common control, as described in
Section 414(b) or (c) of the Code, and the term "Multiemployer Plan" shall mean
any Pension Plan which is a "multiemployer plan" (as such term is defined in
Section 4001(a)(3) of ERISA).

        2.16 Possession of Franchises, Licenses, Etc. The Company and its
Subsidiaries possess all franchises, certificates, licenses, permits and other
authorizations from governmental or political subdivisions or regulatory
authorities and all patents, trademarks, service marks, trade names, copyrights,
licenses and other rights, free from burdensome restrictions, that are necessary
in any material respect to the Company or any of its Subsidiaries for the
ownership, maintenance and operation of their respective properties and assets,
and neither the Company nor any of its Subsidiaries is in violation of any
thereof in any material respect.

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        2.17 Environmental and Other Regulations. The Company and its
Subsidiaries are in compliance with all applicable laws and regulations relating
to protection of the environment and human health, and are in compliance in all
material respects with all other applicable laws and regulations, including,
without limitation, those relating to equal employment opportunity and
employment safety. There are no claims, notices, civil, criminal or
administrative actions, suits, hearings, investigations, inquiries or
proceedings pending or, to the best knowledge of the Company, threatened against
the Company or any Subsidiary that are based on or related to any environmental
matters, including any disposal of hazardous substances at any place, or the
failure to have any required environmental permits, and there are no past or
present conditions that are likely to give rise to any liability or other
obligations of the Company or any Subsidiary under any environmental laws.

        2.18 Patents and Trademarks. Set forth on Schedule 2.18 is a true and
complete list of all patents, patent applications, trademarks, service marks,
trademark and service mark applications, trade names, copyrights and licenses
presently used by the Company or any Subsidiary or necessary for the conduct of
the business of the Company and its Subsidiaries as conducted and as proposed to
be conducted (the "Intellectual Property Rights"). The Company owns, or has the
right to use under the agreements or upon the terms described on Schedule 2.18,
all of the Intellectual Property Rights. To the best of the Company's knowledge,
the business conducted or proposed to be conducted by the Company and its
Subsidiaries does not infringe or violate any of the patents, trademarks,
service marks, trade names, copyrights, licenses, trade secrets or other
proprietary rights of any other Person. Except as set forth on Schedule 2.18, to
the Company's knowledge, no other Person has any right to or interest in any
inventions, improvements, discoveries or other confidential information utilized
by the Company or any Subsidiary in its business.

        2.19 Material Contracts and Obligations. Schedule 2.19 sets forth a list
of the following agreements or commitments of any nature to which the Company or
any Subsidiary is a party or by which it is bound: (a) any agreement relating to
material Intellectual Property Rights, (b) all employment and consulting
agreements, and all employee benefit, bonus, pension, profit-sharing, stock
option, stock purchase and similar plans and arrangements (other than plans or
arrangements providing for less than $10,000 per employee), (c) all
manufacturing, distributor and sales representative agreements and all
agreements with suppliers or vendors if the value of the payments thereunder is
in excess of $100,000, (d) all agreements or commitments that materially
restrict the ability of the Company or any Subsidiary or Affiliate to

                                       10

<PAGE>   15

engage in any business or line of business in any location, (e) all agreements
or commitments relating to indebtedness or guarantees of the Company or any
Subsidiary if the value of the payments thereunder is in excess of $100,000 and
(f) any other agreement or commitment which requires future payments by or to
the Company or any Subsidiary in excess of $100,000 or which is otherwise
material to the Company or any of its Subsidiaries. The Company has delivered or
made available to the Purchasers copies of all of the foregoing agreements and
commitments. To the best knowledge of the Company, all of such agreements and
commitments are valid, binding and in full force and effect.

        2.20 Books and Records. All the books, records and accounts of the
Company and its Subsidiaries are in all material respects true and complete, are
maintained in accordance with good business practice and all laws applicable to
its business, and accurately present and reflect in all material respects all of
the transactions therein described. The Company has previously delivered to the
Purchasers true and complete texts of all of the minutes relating to meetings of
the stockholders, boards of directors and committees of the Company and each
Subsidiary for the past five years.

        2.21 Transactions with Related Parties. Schedule 2.21 sets forth a true
and complete list of the amounts and other essential terms of any contract,
arrangement or transaction currently in effect or effected during the past five
years between the Company or any Subsidiary and any Related Party, other than
(i) arrangements for the payment of salary, including bonuses, for services
rendered to the Company, which arrangements have previously been disclosed to
the Purchasers, (ii) other arrangements with any such Person which in the
aggregate do not involve more than $10,000 or (iii) as previously disclosed in
the SEC Reports.

        2.22 Brokers. Neither the Company nor any Subsidiary has engaged any
finder, broker or investment adviser, and has no obligation to pay any fees, in
connection with the transactions contemplated hereby.

        2.23 Accuracy of Information. None of the representations and warranties
of the Company contained herein or the information, documents or other materials
(other than projections) which have been furnished in writing by the Company or
any of its representatives to the Purchasers in connection with the transactions
contemplated by this Agreement contains any material misstatement of fact, or
omits any material fact necessary to make the statements herein and therein, in
light of the circumstances under which they were made, not misleading. All
projections fur-


                                       11
<PAGE>   16

nished in writing by the Company (i) have been prepared by management of the
Company after a careful analysis of all material data, (ii) are based on
reasonable assumptions by management of the Company and (iii) represent the best
estimate by management of the Company, based upon current reasonable
assumptions, as to the financial performance of the Company and its Subsidiaries
for the periods indicated, but do not represent any guarantee or assurance of
the future financial results of the Company and its Subsidiaries.

        2.24 Offering of Series A Preferred Stock. Neither the Company nor any
Person acting on its behalf has offered any of the Series A Preferred Stock or
any similar securities of the Company for sale to, solicited any offers to buy
any of the Series A Preferred Stock or any similar securities of the Company
from or otherwise approached or negotiated with respect to the Company with any
Person other than the Purchasers and other "Accredited Investors" (as defined in
Rule 501(a) under the Securities Act). Neither the Company nor any Person acting
on its behalf has taken or will take any action (including, without limitation,
any offering of any securities of the Company under circumstances which would
require the integration of such offering with the offering of any of the Series
A Preferred Stock under the Securities Act and the rules and regulations of the
Commission thereunder) which could reasonably be expected to subject the
offering, issuance or sale of any of the Series A Preferred Stock to the
registration requirements of Section 5 of the Securities Act.

        SECTION 3. REPRESENTATIONS AND WARRANTIES OF THE PURCHASERS.

        Each Purchaser represents and warrants as follows:

        3.1 Organization and Qualification. Such Purchaser is either (a) (i)
duly organized and existing in good standing under the laws of the jurisdiction
of its formation and has the power to own its respective property and to carry
on its respective business as now being conducted and (ii) duly qualified to do
business and in good standing in every jurisdiction in which the nature of the
respective business conducted or property owned by it makes such qualification
necessary, except where the failure to so qualify would not prevent consummation
of the transactions contemplated hereby or have a material adverse effect on
such Purchaser's ability to perform its obligations hereunder or (b) a natural
person with the capacity to enter into this Agreement and to consummate the
transactions contemplated hereby.

        3.2 Due Authorization. Such Purchaser has all right, power and authority
to enter into this Agreement and to consummate the transactions contemplated


                                       12
<PAGE>   17

hereby. The execution and delivery of this Agreement by the Purchaser and the
consummation by such Purchaser of the transactions contemplated hereby have been
duly authorized by all necessary action on behalf of such Purchaser. This
Agreement has been duly executed and delivered by the Purchaser and constitutes
a valid and binding agreement of the Purchaser enforceable in accordance with
its terms, except that (i) such enforcement may be subject to bankruptcy,
insolvency, reorganization, moratorium or other similar laws now or hereafter in
effect relating to creditors, rights, and (ii) the remedy of specific
performance and injunctive and other forms of equitable relief may be subject to
equitable defenses and to the discretion of the court before which any
proceeding therefor may be brought.

        3.3 Conflicting Agreements and Other Matters. Neither the execution and
delivery of this Agreement nor the performance by the Purchaser of its
obligations hereunder will conflict with, result in a breach of the terms,
conditions or provisions of, constitute a default under, or require any consent,
approval or other action by or any notice to or filing with any court or
administrative or governmental body pursuant to, the organizational documents or
agreements of the Purchaser or any mortgage, agreement, instrument, order,
judgment, decree, statute, law, rule or regulation to which the Purchaser or any
of its respective properties are subject.

        3.4 Acquisition for Investment. The Purchaser is acquiring the Series A
Preferred Stock being purchased by it for its own account for the purpose of
investment and not with a view to or for sale in connection with any
distribution thereof, and the Purchaser has no present intention or plan to
effect any distribution thereof. The Purchaser acknowledges that the Series A
Preferred Stock has not been registered under the Securities Act and may be
sold or disposed of in the absence of such registration only pursuant to an
exemption from such registration.

        3.5 Brokers or Finders. No agent, broker, investment banker or other
firm or Person, including any of the foregoing that is an Affiliate of the
Purchasers, is or will be entitled to any broker's fee or any other commission
or similar fee from the Purchaser in connection with any of the transactions
contemplated by this Agreement that the Company will be responsible for pursuant
to Section 9.9.

        3.6 Accredited Investor. The Purchaser is an "Accredited Investor"
within the meaning of Rule 501 promulgated under the Securities Act.

        SECTION 4. COVENANTS OF THE COMPANY.




                                       13
<PAGE>   18

        4.1 Limitation on Senior Equity Securities. Without the consent of the
holders of a majority of the then outstanding shares of Series A Preferred
Stock, the Company will not issue any equity securities or any rights, options,
warrants or other securities which are exercisable for, exchangeable for or
convertible into shares of any class of capital stock ranking pari passu or
senior as to dividends or upon liquidation to the Series A Preferred Stock.

        4.2 Compliance with Laws. The Company will, and will cause each
Subsidiary to, comply with all applicable statutes, rules, regulations and
orders of all governmental authorities, with respect to the conduct of its
business and the ownership of its properties, including without limitation,
those relating to protection of the environment and human health, equal
employment opportunity, employee safety, ERISA and international trade laws and
regulations, and apply for obtain and maintain all permits necessary for the
conduct of its business and the ownership of its properties.

        4.3 Preservation of Franchises and Existence. The Company will (i)
maintain its corporate existence, rights and franchises in full force and
effect, and (ii) cause the Subsidiaries to maintain their respective corporate
existences, rights and franchises in full force and effect; provided that
nothing in this Section 4.3 shall prevent the Company or any Subsidiary from
discontinuing its operations in any particular state or at any particular
location or locations within the state, or prevent the corporate existence,
rights and franchises of any Subsidiary from being terminated if, in the
opinion of the Board of Directors, the preservation thereof is no longer
desirable in the conduct of the business of the Company and its Subsidiaries and
the loss thereof is not disadvantageous in any material respect to the holders
of Series A Preferred Stock.

        4.4 Use of Proceeds. The Company will only use the Proceeds for
Permitted Proceeds Uses; provided that, in the case of Retail Proceeds, the
Company may, pending any Retail Proceeds Uses, use Retail Proceeds to pay down
long-term indebtedness so long as the Company has the right to immediately
reborrow such amounts.

        4.5 Insurance. The Company will, and will cause each of the Subsidiaries
to, maintain with insurers believed by the Company to be responsible such
insurance, in such amounts and of such types as are customarily carried under
similar circumstances by companies engaged in the same or a similar business or
having similar properties similarly situated.



                                       14
<PAGE>   19

        4.6 Payment of Taxes and Other Charges. The Company will pay or
discharge, and will cause each of the Subsidiaries to pay or discharge, before
the same shall become delinquent, (i) all taxes, assessments and other
governmental charges or levies imposed upon it or any of its properties or
income (including, without limitation, such as may arise under Sections 4062,
4063, or 4064 of ERISA or any similar provision of law), and (ii) all claims or
demands of materialmen, mechanics, carriers, warehousemen, landlords and other
like Persons which, in the case of either clause (i) or clause (ii), if unpaid,
might result in the creation of a material lien upon any of its properties,
provided, however, that the Company shall not be required to pay or discharge or
cause to be paid or discharged any such tax, assessment, charge or claim whose
amount, applicability or validity is being contested in good faith pursuant to
appropriate proceedings.

        4.7 Effect of Breach. In addition to the rights of THLi under the
Stockholders Agreement, upon the occurrence of an Event of Default and
notification by THLi prior to the two-year anniversary of the First Closing Date
of its desire to add directors in accordance with Section 6.2, then the Board of
Directors shall take all necessary action to increase or decrease the size of
the Board of Directors and to appoint to the Board of Directors a number of
additional members (the "Additional Members") designated by THLi that, when
added to any directors then in office designated solely by THLi, will result in
directors designated by THLi constituting a majority of the entire Board of
Directors. THLi shall be entitled to designate the Additional Members and, for
so long as such Event of Default continues, at each subsequent annual meeting,
THLi shall be entitled to propose (and the Board of Directors shall nominate and
recommend) Persons reasonably acceptable to the Board of Directors as the
Additional Members of the Board of Directors. In the event of any vacancy
arising by reason of the resignation, death, removal or inability to serve of
any Additional Member, THLi shall be entitled to designate a successor to fill
such vacancy for the remaining term of such director. At such times as such
Event of Default shall have been cured or waived, the rights of THLi under this
Section 4.7 shall terminate (and THLi shall cause such Additional Directors to
resign from the Board of Directors), subject to revesting in the event of each
and every subsequent Event of Default.

        4.8 ERISA. Neither the Company nor any Subsidiary shall incur any
material liability with respect to retiree medical or death benefits or unfunded
benefits payable after termination of employment. All employee benefit plans and
arrangements maintained or contributed to by the Company, any Subsidiary or any



                                       15
<PAGE>   20

ERISA Affiliate shall be maintained in compliance in all material respects with
all applicable law, including any reporting requirements. With respect to any
plan maintained by or contributed to by the Company or any Subsidiary, neither
the Company nor any Subsidiary will fail to make any contribution due from it
under the terms of such plan or as required by law. Neither the Company nor any
ERISA Affiliate will permit a Pension Plan to incur an accumulated funding
deficiency (as such term is defined in Section 302 of ERISA or Section 412 of
the Code), whether or not waived, cause a lien or a security interest to attach
to any asset of the Company or any Subsidiary for the benefit of any Plan, or
incur any liability which would be material to the Company or any of its
Subsidiaries under Title IV of ERISA, including withdrawal liability (other than
the payment of premiums, none of which are overdue). Neither the Company nor any
Subsidiary, nor any other Person including any fiduciary, will engage in any
transaction prohibited by Section 406 of ERISA or Section 4975 of the Code which
is reasonably likely to subject the Company, any Subsidiary or any entity that
the Company or any Subsidiary has an obligation to indemnify to any tax or
penalty imposed under Section 4975 of the Code or Section 502 of ERISA.

        4.9 Financial Statements and Other Reports.

               (a) The Company will, as soon as practicable and in any event
        within 60 days after the end of each quarterly period (other than the
        last quarterly period) in each fiscal year, furnish to THLi statements
        of consolidated net income and cash flows and a statement of changes in
        consolidated stockholders' equity of the Company and its Subsidiaries
        for the period from the beginning of the then current fiscal year to the
        end of such quarterly period, and a consolidated balance sheet of the
        Company and its Subsidiaries as of the end of such quarterly period,
        setting forth in each case in comparative form figures for the
        corresponding period or date in the preceding fiscal year, all in
        reasonable detail and certified by an authorized financial officer of
        the Company, subject to changes resulting from year-end adjustments;
        provided, however, that delivery pursuant to clause (iii) below of a
        copy of the Quarterly Report on Form 10-Q of the Company for such
        quarterly period filed with the Commission shall be deemed to satisfy
        the requirements of this clause (i);

               (b) The Company will, as soon as practicable and in any event
        within 100 days after the end of each fiscal year, furnish to THLi
        statements of consolidated net income and cash flows and a statement of
        changes in



                                       16
<PAGE>   21

        consolidated stockholders' equity of the Company and its Subsidiaries
        for such year, and a consolidated balance sheet of the Company and its
        Subsidiaries as of the end of such year, setting forth in each case in
        comparative form the corresponding figures from the preceding fiscal
        year, all in reasonable detail and examined and reported on by
        independent public accountants of recognized national standing selected
        by the Company; provided, however, that delivery pursuant to clause
        (iii) below of a copy of the Annual Report on Form 10-K of the Company
        for such fiscal year filed with the Commission shall be deemed to
        satisfy the requirements of this clause (ii);

               (c) The Company will, promptly upon transmission thereof, furnish
        to each Purchaser copies of all such financial statements, proxy
        statements, notices and reports as it shall send to its stockholders and
        copies of all such registration statements (without exhibits), other
        than registration statements relating to employee benefit or dividend
        reinvestment plans, and all such regular and periodic reports as it
        shall file with the Commission;

               (d) The Company will, promptly after such package becomes
        available, furnish to THLi copies of all financial reporting packages
        prepared for management of the Company; and

               (e) Until the two-year anniversary of the First Closing Date, the
        Company will, as soon as practicable, and in any event within 5 days
        after the end of each month, furnish to THLi and GECC detailed reports,
        and any other information THLi and GECC may reasonably request, relating
        to (i) the use of Proceeds by the Company and its Subsidiaries and (ii)
        the Company's compliance with the Retail Plan and the E-Commerce Plan;

               (f)  The Company will promptly furnish to THLi copies of any
        reports furnished to GECC pursuant to the Note Agreement; and

               (g) The Company will promptly furnish to THLi copies of any
        compliance certificates furnished to lenders in respect of indebtedness
        of the Company and its Subsidiaries and, with reasonable promptness,
        furnish to each Purchaser such other financial and other data of the
        Company and its Subsidiaries as such Purchaser may reasonably request,
        including, but not limited to, operating financial information for each
        retail store owned or operated by the Company or any of its
        Subsidiaries.




                                       17
<PAGE>   22

        4.10 Inspection of Property. The Company will permit representatives of
THLi to visit and inspect, at THLi's expense, any of the properties of the
Company and its Subsidiaries, to examine the corporate books and make copies or
extracts therefrom and to discuss the affairs, finances and accounts of the
Company and its Subsidiaries with the principal officers of the Company, all at
such reasonable times, upon reasonable notice and as often as such Purchaser may
reasonably request.

        4.11 Lost, Stolen, Damaged and Destroyed Stock Certificates. Upon
receipt of evidence satisfactory to the Company of the loss, theft, destruction
or mutilation of any certificate for shares of Series A Preferred Stock (or any
certificate for the shares of Common Stock into which the Series A Preferred
Stock is convertible) and in the case of loss, theft or destruction, upon
delivery of an indemnity satisfactory to the Company (which, in the case of any
Purchaser, may be an undertaking by such Purchaser so to indemnify the
Company), or, in the case of mutilation, upon surrender and cancellation
thereof, the Company will issue a new certificate of like tenor for a number of
shares of Series A Preferred Stock (or, if applicable, shares of Common Stock
into which the Series A Preferred Stock is convertible) equal to the number of
shares of such stock represented by the certificate lost, stolen, destroyed or
mutilated.

        4.12 Related Party Transactions. The Company shall not, directly or
indirectly, and shall not permit any of its Subsidiaries to, directly or
indirectly, enter into, amend or terminate any contract, arrangement or
transaction with a Related Party, other than (i) any action to terminate the
Consumer Credit Card Agreement by and among Krause's Sofa Factory, Castro
Convertible Corporation and Monogram Credit Bank of Georgia, dated as of April
27, 1997 and (ii) the payment of salary and benefits pursuant to employment
agreements entered into in the ordinary course of business.

        4.13 Operations in Accordance with Business Plan. The business and
operations of the Company and its Subsidiaries shall be conducted in all
material respects in accordance with the Company's annual business plan as
approved by a majority of the Board of Directors, which majority must include
the GECC Designee and the THLi Designees (each as defined in the Stockholders
Agreement), except for such changes which shall have been approved in accordance
with Section 2.2(u) of the Stockholders Agreement. The Company shall submit the
E-Commerce Plan to the Board of Directors for approval no later than 90 days
from the First Closing Date.




                                       18
<PAGE>   23

        4.14 Reservation of Shares. From and after the 15th day following the
first meeting of stockholders of the Company occurring on or after the First
Closing Date, the Company shall at all times reserve and keep available out of
its authorized but unissued shares of Common Stock solely for the purpose of
effecting the conversion of the shares of the Series A Preferred Stock, such
number of its shares of Common Stock as shall from time to time be sufficient to
effect the conversion of all outstanding shares of the Series A Preferred
Stock.

        4.15 Notice of Breach. As promptly as practicable, and in any event not
later than ten Business Days after senior management of the Company becomes
aware of any breach by the Company of any provision of this Agreement,
including, without limitation, this Article 4, the Company shall provide the
Purchasers with written notice specifying the nature of such breach and any
actions proposed to be taken by the Company to cure such breach.

        4.16 Limitation on Dividends. The Company shall not pay any dividends on
Common Stock so long as any shares of Series A Preferred Stock remain out
standing.

        4.17 Right of First Refusal. Subject to the terms and conditions
specified in this Section 4.17, the Company hereby grants to THLi or any of its
designees (collectively, the "First Refusal Stockholders") a right of first
offer with respect to future sales by the Company of its Offered Shares (as
hereinafter defined).

        Each time the Company proposes to offer any shares of, or securities
convertible into or exercisable or exchangeable for any shares of, any class of
its capital stock ("Offered Shares"), the Company shall first make an offering
of such Offered Shares to the First Refusal Stockholders in accordance with the
following provisions:

               (a) The Company shall deliver a notice in accordance with Section
        9.5 of this Agreement ("Notice") to THLi stating (i) its bona fide
        intention to offer such Offered Shares, (ii) the number of such Offered
        Shares to be offered, and (iii) the price and terms, if any, upon which
        it proposes to offer such Offered Shares.

               (b) Within 15 days after delivery of the Notice, the First
        Refusal Stockholders may elect to purchase or obtain, at the price and
        on the terms specified in the Notice, up to that portion of such Offered
        Shares that equals the proportion that the number of shares of Common
        Stock issued and held



                                       19
<PAGE>   24

        (or issuable upon conversion and exercise of all convertible or
        exercisable securities then held by THLi and its Affiliates) bears to
        the total number of shares of Common Stock then outstanding (assuming
        full conversion and exercise of all outstanding convertible or
        exercisable securities).

               (c) The right of first offer in this Section 4 shall not be
        applicable to any issuance or sale of any of the following securities:

               (i) Common Stock issued pursuant to any stock split, dividend or
        distribution payable in additional shares of Common Stock or other
        securities or rights convertible into, or entitling the holder thereof
        to receive directly or indirectly, additional shares of Common Stock
        without payment of any consideration by such holder, provided that all
        holders of capital stock of the Company and options or warrants or other
        securities exercisable or exchangeable for or convertible into, capital
        stock of the Company receive their pro rata share (on a common
        equivalent basis) of such Common Stock,

               (ii) Common Stock issuable or issued to employees, consultants or
        directors of the Company directly or pursuant to a stock option plan or
        restricted stock plan, or other similar arrangements related to
        compensation for services in effect on the date of this Agreement, or
        thereafter approved by a majority vote of THLi Designees;

               (iii) capital stock issued upon conversion or exercise of
        warrants, options or other securities outstanding immediately following
        the First Closing; or

               (iv) Common Stock issued in a bona fide firm commitment under
        written offering to the public.

        SECTION 5. RESTRICTIONS ON TRANSFER. Neither the Purchasers or any of
their respective Affiliates shall, directly or indirectly, sell, transfer,
pledge, encumber or otherwise dispose of (collectively, a "Transfer") any of the
Series A Preferred Stock or Common Stock received upon conversion of the Series
A Preferred Stock, except for: (a) Transfers to or between Affiliates who agree
to be bound by the provisions of this Agreement; (b) Transfers of Series A
Preferred Stock or Common Stock received upon conversion of the Series A
Preferred Stock pursuant to the exercise of the registration rights set forth in
the Registration Rights Agreement; or (c) other Transfers that comply with the
provisions of the Securities Act. The Company may



                                       20
<PAGE>   25

require, in connection with any Transfer pursuant to the preceding clause (c),
an opinion of counsel to the Purchaser that such Transfer complies with the
provisions of the Securities Act.

        SECTION 6. EVENT OF DEFAULT AND REMEDIES.

        6.1 Event of Default. The occurrence of any of the events set forth on
Schedule 6.1 prior to the two-year anniversary of the First Closing Date shall
constitute an Event of Default under this Agreement.

        6.2 Remedies. The Company shall notify the Purchasers immediately upon
becoming aware of any Event of Default. If an Event of Default occurs and is
continuing, then in every such case:

               (a) THLi at its option, shall have the right to either:

                    (i) demand immediate redemption of up to its Maximum Number
(as such term is defined in the Certificate of Designation) of shares of Series
A Preferred Stock pursuant to paragraph 5(c) of the Certificate of Designation,
or

                    (ii) nominate and designate additional members of the Board
of Directors pursuant to Section 4.7 hereof; and

               (b) without limiting the foregoing, any Purchaser may enforce its
rights by suit in equity, by action at law, or by any other appropriate
proceedings, whether for the specific performance (to the extent permitted by
law) of any covenant or agreement contained in this Agreement or the
Certificate of Incorporation or in aid of the exercise of any power granted in
this Agreement or the Certificate of Incorporation.

        If THLi elects to demand redemption pursuant to clause (a)(i) above,
each other holder of Series A Preferred Stock shall also be entitled to demand
immediate redemption of such shares of Series A Preferred Stock permitted under
paragraph 5(c) of the Certificate of Designation.

        6.3 Conduct No Waiver. No course of dealing on the part of any holder,
nor any delay or failure on the part of any holder to exercise any of its
rights, shall operate as a waiver of such right or otherwise prejudice such
holder's rights, powers and remedies.



                                       21
<PAGE>   26

        6.4 Remedies Cumulative. No right or remedy conferred upon or reserved
to the holders of Series A Preferred Stock under this Agreement is intended to
be exclusive of any other right or remedy, and every right and remedy shall be
cumulative and in addition to every other right and remedy given hereunder or
now and hereafter existing under applicable law. Every right and remedy given by
this Agreement or by applicable law to the holders of Series A Preferred Stock
may be exercised from time to time and as often as may be deemed expedient by
the holders.

        SECTION 7. CONDITIONS.

        7.1 Conditions to Each Party's Obligations to Effect the Transactions
Contemplated Hereby. The respective obligations of each party to effect the
transactions contemplated by this Agreement shall be subject to the fulfillment
at or prior to the applicable Closing Date of the following conditions:

               (a) No temporary restraining order, preliminary or permanent
        injunction or other order or decree by any court of competent
        jurisdiction which prevents the consummation of the transactions
        contemplated hereby or imposes material conditions with respect thereto
        shall have been issued and remain in effect (each party agreeing to use
        its reasonable efforts to have any such injunction, order or decree
        lifted).

               (b) No action shall have been taken, and no statute, rule or
        regulation shall have been enacted, by any state or Federal government
        or governmental agency which would prevent the consummation of the
        transactions contemplated by this Agreement or imposes material
        conditions with respect thereto.

               (c) All consents and approvals of governmental entities legally
        required for the consummation of the transactions contemplated by this
        Agreement shall have been obtained and be in effect at the applicable
        Closing Date, except those for which failure to obtain such consents and
        approvals would not, individually or in the aggregate, have a Material
        Adverse Effect or materially impair the ability of any party to this
        Agreement to consummate the transactions contemplated by this Agreement.

        7.2 Conditions to Purchasers' Obligations to Effect the Transactions
Contemplated Hereby. The obligations of the Purchasers to effect the
transactions



                                       22
<PAGE>   27

contemplated by this Agreement shall be subject to the fulfillment at or prior
to the applicable Closing Date of the following additional conditions:

               (a) The Company shall have performed in all material respects all
        obligations required to be performed by it under this Agreement at or
        prior to the applicable Closing Date, and the representations and
        warranties of the Company contained in this Agreement shall be true and
        correct in all material respects (if not qualified by materiality) and
        true and correct (if so qualified) on and as of the date of this
        Agreement and at and as of the applicable Closing Date as if made at and
        as of the applicable Closing Date, except to the extent that any such
        representation or warranty expressly relates to another date (in which
        case, as of such date).

               (b) The consent or approval of each third party whose consent or
        approval shall be required in connection with the transactions
        contemplated hereby shall have been obtained.

               (c) The Company and the stockholders listed on the signature
        pages thereto shall have executed and delivered the Stockholders
        Agreement substantially in the form attached hereto as Exhibit A.

               (d) Purchasers shall have received an opinion of Morrison &
        Foerster LLP, counsel to the Company, substantially in the form attached
        hereto as Exhibit B.

               (e) The Company and the stockholders listed on the signature
        pages thereto shall have executed and delivered the Registration Rights
        Agreement substantially in the form attached hereto as Exhibit C.

               (f) Since the date of this Agreement, there shall not have been
        any change or events which have resulted or would in reasonable
        probability result in a Material Adverse Effect.

               (g) The Company, GECC and JOL shall have executed and delivered
        the Indebtedness Amendment substantially in the form attached hereto as
        Exhibit D.




                                       23
<PAGE>   28

               (h) The Company shall have filed the Certificate of Designation
        substantially in the form attached hereto as Exhibit E with the Delaware
        Secretary of State.

               (i) Purchasers shall have completed their business, legal and
        financial due diligence review and the results of such review shall be
        satisfactory to Purchasers in their sole judgment.

        SECTION 8. INTERPRETATION.

        8.1 Definitions.

        "Affiliate" and "Associate" shall have the respective meanings ascribed
to such terms in Rule 12b-2 of the General Rules and Regulations under the
Exchange Act.

        "beneficially own" with respect to any Series A Preferred Stock shall
mean having "beneficial ownership" of such Series A Preferred Stock (as
determined pursuant to Rule 13d-3 under the Exchange Act), including pursuant to
any agreement, arrangement or understanding, whether or not in writing.

        "Board of Directors" shall mean the board of directors of the Company.

        "Business Day" shall mean any day other than a Saturday, Sunday, or a
day on which banking institutions in the State of New York are authorized or
obligated by law or executive order to close.

        "Certificate of Designation" shall mean the Certificate of Designation
of Series A Convertible Preferred Stock of the Company substantially in the form
attached hereto as Exhibit E.

        "Code" shall mean the Internal Revenue Code of 1986, as amended.

        "Consolidated" or "consolidated," when used with reference to any
financial term in this Agreement (but not when used with respect to any tax
return or tax liability), shall mean the aggregate for two or more Persons of
the amounts signified by such term for all such Persons, with inter-company
items eliminated and, with respect to earnings, after eliminating the portion of
earnings properly attributable to minority interests, if any, in the capital
stock of any such Person or attribut-




                                       24
<PAGE>   29

able to shares of preferred stock of any such Person not owned by any other such
Person.

        "E-Commerce Plan" shall mean a business plan setting forth the Company's
planned business to business and E-commerce activities, including detailed
information with respect to E-Commerce Proceed Uses, strategy, implementation
of strategy, milestone targets and a timeline with respect thereto, as such
business plan may be amended from time to time in accordance with Section 2.2(u)
of the Stockholders Agreement.

        "E-Commerce Proceed Uses" shall mean the use of Proceeds to build
infrastructure and sales and marketing capabilities for (including the
recruitment of appropriate talent associated with) business-to-business
activities and e-commerce activities, including commerce related to transactions
on the Internet and such further uses described in the E-Commerce Plan.

        "ERISA" shall mean the Employee Retirement Income Security Act of 1974,
as amended.

        "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended, or any successor Federal statute, and the rules and regulations of the
Commission thereunder, all as the same shall be in effect at the time. Reference
to a particular section of the Securities Exchange Act of 1934, as amended,
shall include reference to the comparable section, if any, of any such successor
Federal statute.

        "GECC" shall mean, collectively, General Electric Capital Corporation, a
New York corporation and GE Capital Equity Investments, Inc., a Delaware
corporation.

        "Individual Purchasers" shall mean the Purchasers other than THLi, GECC
and Permal.

        "Initial Purchasers" shall mean THLi, GECC and Permal.

        "JOL" shall mean Japan Omnibus Ltd., an international business
corporation incorporated in the British Virgin Islands.

        "Note Agreement" shall mean, collectively, the Securities Purchase
Agreement dated as of August 26, 1996 between the Company and GECC and the
Supple-



                                       25
<PAGE>   30

mental Securities Purchase Agreement, dated as of August 14, 1997, among the
Company GECC and JOL, in each case, as amended.

        "PBGC" shall mean the Pension Benefit Guaranty Corporation, or any
successor thereto.

        "Pension Plan" shall mean any multiemployer plan or single employer
plan, as defined in Section 4001 of ERISA, that is subject to Title IV of ERISA,
that the Company, any Subsidiary or any ERISA Affiliate maintains or is or ever
has been obligated to contribute to for the benefit of employees or former
employees of the Company, any Subsidiary or any ERISA Affiliate.

        "Permal" shall mean those entities and individuals constituting the
Permal Group as set forth on Schedule C to the Stockholders Agreement.

        "Permitted Proceeds Uses" shall mean Retail Proceed Uses or E-Commerce
Proceed Uses.

        "Person" shall mean any individual, firm, corporation, partnership or
other entity, and shall include any successor (by merger or otherwise) of such
entity.

        "Proceeds" shall mean the proceeds from the sale of the Series A
Preferred Stock pursuant to this Agreement.

        "Related Party" shall mean any officer, director or beneficial holder of
3% or more of the outstanding shares of capital stock of the Company or any
Subsidiary, any spouse, former spouse, child, parent, parent of a spouse,
sibling or grandchild of any such officer, director or beneficial holder of the
Company or any Subsidiary, and any Affiliate or Associate of any of the
foregoing Persons; provided, however, that neither THLi nor GECC shall be deemed
to be a Related Party.

        "Retail Plan" shall mean a business plan setting forth the Company's
planned retail activities, including detailed information with respect to Retail
Proceed Uses, Strategy, implementation of Strategy, milestone targets and a time
line with respect thereto, as such business plan may be amended from time to
time in accordance with section 2.2(a) of the Stockholders Agreement.

        "Retail Proceed Uses" shall mean the use of Proceeds to (i) repay the
Loan and Security Agreement, dated as of January 20, 1995, as amended, by and
between



                                       26
<PAGE>   31

Congress Financial Corporation (Western), Krause's Sofa Factory and Castro
Convertible Corporation (the "Credit Agreement"), (ii) make capital expenditures
related to the opening of new stores, (iii) for working capital purposes in
connection with the Company's retail business and (iv) for such further uses
described in the Retail Plan.

        "Securities Act" shall mean the Securities Act of 1933, as amended, or
any successor federal statute, and the rules and regulations of the Commission
thereunder, all as the same shall be in effect at the time.

        "Subsidiary" of any Person means any corporation or other entity of
which a majority of the voting power or the Voting Securities or equity interest
is owned, directly or indirectly, by such Person.

        "THLi" shall mean, collectively, TH Lee.Putnam Internet Partners, L.P.
and TH Lee.Putnam Internet Parallel Partners, L.P., together with their
affiliates.

        "Voting Securities" of any Person shall mean at any time shares of any
class of capital stock of such Person which are then entitled to vote generally
in the election of directors.

        8.2 Accounting Principles. The character or amount of any asset,
liability, capital account or reserve and of any item of income or expense
required to be determined pursuant to this Agreement, and any consolidation or
other accounting computation required to be made pursuant to this Agreement, and
the construction of any definition in this Agreement containing a financial
term, shall be determined or made, as the case may be, in accordance with
generally accepted accounting principles, to the extent applicable, unless such
principles are inconsistent with the express requirements of this Agreement.
References in this Agreement to a fiscal year refer to the period ending on the
last Sunday of January of the following calendar year as determined by the 52/53
retail fiscal year. (For example, 1998 fiscal year refers to the fiscal year
ending January 31, 1999.)

        SECTION 9. MISCELLANEOUS.

        9.1 Severability. If any term, provision, covenant or restriction of
this Agreement or any exhibit hereto is held by a court of competent
jurisdiction to be invalid, void or unenforceable, the remainder of the terms,
provisions, covenants and restrictions of this Agreement and such exhibits shall
remain in full force and effect



                                       27
<PAGE>   32

and shall in no way be affected, impaired or invalidated. It is hereby
stipulated and declared to be the intention of the parties that they would have
executed the remaining terms, provisions, covenants and restrictions without
including any of such which may be hereafter declared invalid, void or
unenforceable.

        9.2 Specific Enforcement. Each Purchaser, on the one hand, and the
Company, on the other, acknowledge and agree that irreparable damage would occur
in the event that any of the provisions of this Agreement were not performed in
accordance with their specific terms or were otherwise breached. It is
accordingly agreed that the parties shall be entitled to an injunction to
prevent breaches of the provisions of this Agreement and to enforce specifically
the terms and provisions hereof in any court of the United States or any state
thereof having jurisdiction, this being in addition to any other remedy to which
they may be entitled at law or equity.

        9.3 Entire Agreement. This Agreement (including the documents set forth
in the exhibits hereto) contains the entire understanding of the parties with
respect to the transactions contemplated hereby.

        9.4 Counterparts. This Agreement may be executed in one or more
counterparts, all of which shall be considered one and the same agreement, and
shall become effective when one or more of the counterparts have been signed by
each party and delivered to the other parties, it being understood that all
parties need not sign the same counterpart.

        9.5 Notices and Other Communications. All notices, consents, requests,
instructions, approvals, financial statements, proxy statements, reports and
other communications provided for herein shall be in writing and shall be
delivered personally, by facsimile or sent by prepaid overnight courier service,
to:

               The Company:

               Krause's Furniture, Inc.
               200 North Berry Street
               Brea, CA 92821-3903
               Facsimile #: (714) 990-3561
               Attention: Philip M. Hawley

               With a copy to:



                                       28
<PAGE>   33

               Krause's Furniture, Inc.
               200 North Berry Street
               Brea, CA 92821-3903
               Facsimile #: (714) 990-3561
               Attention: Judith O. Lasker, Esq.

               and

               Morrison & Foerster LLP
               555 West 5th Street, Suite 3500
               Los Angeles, CA  90013-1024
               Facsimile #: (213) 892-5454
               Attention: Charles Kaufman, Esq.

               Each Purchaser:

               At the address or facsimile number set forth on the signature
               pages hereto.

               With a copy to:

               Skadden, Arps, Slate, Meagher & Flom LLP
               300 South Grand Avenue
               Suite 3400
               Los Angeles, California  90071
               Facsimile #:  (213) 687-5600
               Attention: Michael A. Woronoff, Esq.

or to such other address as any party may, from time to time, designate in a
written notice given in a like manner.

        9.6 Amendments. This Agreement may be amended as to the Purchasers and
their successors and assigns, and the Company may take any action herein
prohibited, or omit to perform any act required to be performed by it, if the
Company shall obtain (i) the written consent of the Purchasers and/or such
successors and assigns who are the registered holders of not less than a
majority of the outstanding shares of Series A Preferred Stock then held by the
Purchasers and their successors or assigns and (ii) the written consent of THLi;
provided, however, that without the consent of each holder affected, however, no
amendment or waiver may (with



                                       29
<PAGE>   34

respect to any shares of Series A Preferred Stock held by a nonconsenting holder
of shares of Series A Preferred Stock):

               (a) reduce the aggregate number of shares of Series A Preferred
        Stock whose holders must consent to an amendment or waiver of any
        provision of this Agreement; or

               (b) make any change in the foregoing amendment and waiver
        provisions.

        This Agreement may not be waived, changed, modified, or discharged
orally, but only by an agreement in writing signed by the party or parties
against whom enforcement of any waiver, change, modification or discharge is
sought or by parties with the right to consent to such waiver, change,
modification or discharge on behalf of such party.

        9.7 Cooperation. Each Purchaser and the Company agree to take, or cause
to be taken, all such further or other actions as shall reasonably be necessary
to make effective and consummate the transactions contemplated by this
Agreement.

        9.8 Successors and Assigns. All covenants and agreements contained
herein shall bind and inure to the benefit of the parties hereto and their
respective successors and assigns. Any Purchaser may (but shall not be required
to) assign any or all of its rights under this Agreement to any transferee of
any Series A Preferred Stock; provided that THLi may only assign its rights
under Section 4 to a transferee of at least 30% of the Stock held by THLi as of
the date of this Agreement (calculated as if all shares of Series A Preferred
Stock had been converted into shares of Common Stock as of the date of such
calculation). If THLi assigns any or all of its rights under Section 4, such
rights shall only be exercised by holders of more than 50% of the Stock held by
THLi as of the date of this Agreement (calculated as if all shares of Series A
Preferred Stock had been converted into shares of Common Stock as of the date of
such calculation). This Agreement may not be assigned by the Company.

        9.9 Expenses and Remedies.

               (a) The Company agrees to pay THLi for all reasonable outside
        legal and consulting fees of THLi in connection with this Agreement and
        the consummation of all transactions contemplated hereby, which costs
        shall not



                                       30
<PAGE>   35

        exceed $50,000, and all costs and expenses relating to any future
        amendment or supplement to this Agreement or the Series A Preferred
        Stock (or any proposal by the Company for such amendment or supplement)
        whether or not consummated or any waiver or consent with respect thereto
        (or any proposal for such waiver or consent) whether or not consummated,
        and all costs and expenses of THLi relating to the enforcement of this
        Agreement, the Registration Rights Agreement or the Series A Preferred
        Stock.

               (b) The Company further agrees to indemnify and save harmless
        each Purchaser and each Purchaser's officers, directors, partners,
        employees, trustees and agents, each Person who controls such Purchaser
        within the meaning of the Securities Act or the Exchange Act, from and
        against any and all costs, expenses, damages or other liabilities
        resulting from any breach of this Agreement by the Company or any legal,
        administrative or other proceedings arising out of the transactions
        contemplated hereby (other than such costs, expenses, damages or other
        liabilities resulting, directly or indirectly, (i) from the breach by
        such Purchaser of any of its representations, warranties or other
        agreements contained herein, (ii) from the gross negligence or willful
        misconduct of such Purchaser or any of its officers, directors,
        partners, employees or agents, or any Person who controls such Purchaser
        within the meaning of the Securities Act or the Exchange Act or (iii)
        from an ERISA violation resulting from any action or inaction by such
        Purchaser, other than an ERISA violation resulting from a breach by the
        Company of this Agreement); provided, however, that, if and to the
        extent that such indemnification is unenforceable for any reason, the
        Company shall make the maximum contribution to the payment and
        satisfaction of such indemnified liability which shall be permissible
        under applicable laws.

               (c) The indemnified party under this Section 9.9 will, promptly
        after the receipt of notice of the commencement of any action against
        such indemnified party in respect of which indemnity may be sought from
        the Company on account of an indemnity agreement contained in this
        Section 9.9 notify the Company in writing of the commencement thereof.
        The omission of any indemnified party so to notify the Company of any
        such action shall not relieve the Company from any liability which it
        may have to such indemnified party except to the extent the Company
        shall have been prejudiced by the omission of such indemnified party so
        to notify the Company, pursuant to this Section 9.9. In case any such
        action shall be brought against any indemnified party and it shall
        notify the Company of the commencement thereof,



                                       31
<PAGE>   36
        the Company shall be entitled to participate therein and, to the extent
        that it may wish, to assume the defense thereof, with counsel reasonably
        satisfactory to such indemnified party, and after notice from the
        Company to such indemnified party of its election so to assume the
        defense thereof, the Company will not be liable to such indemnified
        party under this Section 9.9 for any legal or other expense subsequently
        incurred by such indemnified party in connection with the defense
        thereof nor for any settlement thereof entered into without the consent
        of the Company; provided, however, that (i) if the Company shall elect
        not to assume the defense of such claim or action or (ii) if the
        indemnified party reasonably determines (x) that there may be a conflict
        between the positions of the Company and of the indemnified party in
        defending such claim or action or (y) that there may be legal defenses
        available to such indemnified party different from or in addition to
        those available to the Company, then separate counsel for the
        indemnified party shall be entitled to participate in and conduct the
        defense, in the case of (i) and (ii) (x), or such different defenses, in
        the case of (ii)(y), and the Company shall be liable for any reasonable
        legal or other expenses incurred by the indemnified party in connection
        with the defense. The obligations of the Company to each indemnified
        party hereunder shall be separate obligations, and the Company's
        liability to any such indemnified party hereunder shall not be
        extinguished solely because any other indemnified party is not entitled
        to indemnity hereunder. The obligations of the Company under this
        Section 9.9 shall survive the redemption or purchase by the Company of
        the shares of Series A Preferred Stock purchased by any Purchaser, any
        transfer of the Series A Preferred Stock by any Purchaser and the
        termination of this Agreement, the Series A Preferred Stock, the
        Stockholders Agreement and any of the other documents executed in
        connection herewith.

        9.10 Survival of Representations and Warranties. All representations and
warranties contained herein or made in writing by any party in connection
herewith shall survive the execution and delivery of this Agreement and the
issuance and delivery of the Series A Preferred Stock, regardless of any
investigation made by or on behalf of any party.

        9.11 Transfer of Series A Preferred Stock. (a) Each Purchaser
understands and agrees that the Series A Preferred Stock has not been registered
under the Securities Act or the securities laws of any state and that they may
be sold or otherwise disposed of only in one or more transactions registered
under the Securities Act and, where applicable, such laws or transactions as to
which an exemption



                                       32
<PAGE>   37

from the registration requirements of the Securities Act and, where applicable,
such laws are available. Each Purchaser acknowledges that, except as provided in
the Registration Rights Agreement, such Purchaser has no right to require the
Company to register the Series A Preferred Stock. Each Purchaser understands and
agrees that each certificate representing the Series A Preferred Stock shall
bear legends substantially in the form as follows:

               "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
        REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT") OR
        THE SECURITIES LAWS OF ANY STATE AND MAY NOT BE SOLD OR OTHERWISE
        DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER
        SUCH ACT AND APPLICABLE STATE SECURITIES LAWS OR AN APPLICABLE EXEMPTION
        TO THE REGISTRATION REQUIREMENTS OF SUCH ACT OR SUCH LAWS."

               "THE TRANSFER OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE
        IS RESTRICTED BY A STOCKHOLDERS AGREEMENT BY AND AMONG KRAUSE'S
        FURNITURE, INC. (THE "COMPANY") AND THE STOCKHOLDERS PARTIES THERETO
        (THE "STOCKHOLDERS AGREEMENT"), A COPY OF WHICH IS ON FILE AT THE
        OFFICES OF THE COMPANY."

               "IN ADDITION TO THE RESTRICTIONS SET FORTH IN THE STOCKHOLDERS
        AGREEMENT, THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO
        THE RESTRICTIONS SET FORTH IN A SECURITIES PURCHASE AGREEMENT BY AND
        AMONG THE COMPANY AND THE PURCHASERS LISTED ON THE SIGNATURE PAGES
        THERETO, A COPY OF EACH OF WHICH IS ON FILE AT THE OFFICES OF THE
        COMPANY."

        9.12 Governing Law; Consent to Jurisdiction. This Agreement shall be
governed by and construed in accordance with the laws of the State of New York,
including, without limitation, Sections 5-1401 and 5-1402 of the New York
General Obligations Law and New York Civil Practice Laws and Rules 327(b). Each
of the parties hereto hereby irrevocably and unconditionally consents to submit
to the exclusive jurisdiction of the courts of the State of New York and of the
United States of America, in each case located in the County of New York, for
any action, proceeding or investigation in any court or before any governmental
authority ("litigation") arising out of or relating to this Agreement and the
transactions contemplated hereby (and agrees not to commence any litigation
relating thereto except in such courts), and further agrees that service of any
process, summons, notice or document by U.S.



                                       33
<PAGE>   38

Registered Mail to its respective address set forth in this Agreement shall be
effective service of process for any litigation brought against it in any such
court. Each of the parties hereto hereby irrevocably and unconditionally waives
any objection to the laying of venue of any litigation arising out of this
Agreement or the transactions contemplated hereby in the courts of the State of
New York or the United States of America, in each case located in the County of
New York, and hereby further irrevocably and unconditionally waives and agrees
not to plead or claim in any such court that any such litigation brought in any
such court has been brought in an inconvenient forum. Each of the parties
irrevocably and unconditionally waives, to the fullest extent permitted by
applicable law, any and all rights to trial by jury in connection with any
litigation arising out of or relating to this Agreement or the transactions
contemplated hereby.

        9.13 Publicity. Each of the parties hereto agrees that it will make no
statement regarding the transactions contemplated hereby which is inconsistent
with the press release agreed to by the parties hereto. Notwithstanding the
foregoing, each of the parties hereto may, in document required to be filed by
it with the Commission or other regulatory bodies, make such statements with
respect to the transactions contemplated hereby as each may be advised is
legally necessary upon advice of its counsel.

        9.14 Signatures. This Agreement shall be effective upon delivery of
original signature pages or facsimile copies thereof executed by each of the
parties hereto.




                                       34
<PAGE>   39

        IN WITNESS WHEREOF, the Company and the Purchasers have caused this
agreement to be executed and delivered by their respective officers thereunto
duly authorized.

                                        KRAUSE'S FURNITURE, INC.



                                        By:
                                           -----------------------------------
                                           Name: Robert A. Burton
                                           Title: Executive Vice President/CFO





                                       35
<PAGE>   40

                                   TH LEE.PUTNAM INTERNET PARTNERS, L.P.

                                   By:     TH LEE.PUTNAM INTERNET FUND
                                           ADVISORS, L.P., its General Partner

                                   By:     TH LEE.PUTNAM INTERNET FUND
                                           ADVISORS, LLC, its General Partner


                                   By:________________________________________
                                      Name: Christine Kim
                                      Title: Vice President


                                   Address:    200 Madison Avenue, Suite 2225
                                               New York, New York  10016
                                               Facsimile #:  (212) 951-8655
                                               Attention:  Christine Kim


                                   Number of Shares: 134,000

                                   Purchase Price:  $6,700,000



<PAGE>   41

                                   TH LEE.PUTNAM INTERNET PARALLEL
                                   PARTNERS, L.P.

                                   By:     TH LEE.PUTNAM INTERNET FUND
                                           ADVISORS, L.P., its General Partner

                                   By:     TH LEE.PUTNAM INTERNET FUND
                                           ADVISORS, LLC, its General Partner


                                   By:________________________________________
                                      Name: Christine Kim
                                      Title: Vice President


                                   Address:    200 Madison Avenue, Suite 2225
                                               New York, New York  10016
                                               Facsimile #:  (212) 951-8655
                                               Attention:  Christine Kim


                                   Number of Shares: 126,000

                                   Purchase Price:  $6,300,000

<PAGE>   42

                                   GE CAPITAL EQUITY INVESTMENTS, INC.



                                   By:________________________________________
                                      Name: George L. Hashbarger, Jr.
                                      Title: Senior Vice President


                                   Address:    260 Long Ridge Road
                                               Stamford, Connecticut  06927
                                               Facsimile #:  (203)
                                               Attention:


                                   Number of Shares: 20,000

                                   Purchase Price:  $1,000,000



<PAGE>   43
                   ASCEND PARTNERS, L.P.



                   By:
                      ----------------------------------------
                      Name: Malcom Fairbairn
                      Title: Managing Member, Ascend Capital, LLC
                             (General Partner for Ascend Partners, LP)

                   Address:       One Valley High
                                  Lafayette, California  94549
                                  Facsimile #:
                                  Attention: Malcolm Fairbairn, c/o Emily Wang


                   Number of Shares: 6,500

                   Purchase Price:  $325,000


                   ATCO DEVELOPMENT, INC.



                   By:
                      ----------------------------------------
                      Name: Kamal Abdelnour
                      Title:  President and CEO

                   Address:       11777 Katy Freeway, Suite 175
                                  Houston, Texas  77079
                                  Facsimile #:
                                  Attention: Kamal Abdelnour


                   Number of Shares: 5,000

                   Purchase Price:  $250,000


                                                                               5


<PAGE>   44

                   BANK INSINGER De BEAUFORT



                   By:
                      ----------------------------------------
                   Name: Frans Kee   J.J. Human
                   Its: Director


                   Address:       11777 San Vicente Boulevard, Suite 702
                                  Los Angeles, California  90049
                                  Facsimile #:
                                  Attention: Diana Deryez


                   Number of Shares: 3,750

                   Purchase Price:  $187,500


                   LARRY BLACK



                   By:________________________________________


                   Address:       c/o Black and Company
                                  One SW Columbia Street
                                  Portland, Oregon 97258
                                  Facsimile #:



                   Number of Shares:  1,000

                   Purchase Price:  $50,000


                                                                               6


<PAGE>   45
                   BRANAGH REVOCABLE TRUST

                   Authorized Investment Advisor:

                   By:
                      ----------------------------------------
                         Name: Peter W. Branagh
                         Title:    Trustee

                   By:
                      ----------------------------------------
                         Name: Ramona Y. Branagh
                         Title: Trustee

                   Address:       c/o Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California  94563
                                  Facsimile #:
                                  Attention:  Sanford J. Colen


                   Number of Shares: 300

                   Purchase Price:  $15,000


                   MATTHEW WILLIAM CLARKE



                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       314 Edgar Gooch Rd.
                                  Hazel Green, AL 35750

                   Number of Shares: 2,000

                   Purchase Price:  $100,000


                                                                               7


<PAGE>   46
                   SANFORD J. COLEN



                   By:
                      ----------------------------------------
                      Sanford J. Colen

                   Address:       Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California 94563
                                  Facsimile #:
                                  Attention: Sanford J. Colen

                   Number of Shares: 900

                   Purchase Price:  $45,000


                   AARON J. COLEN, UTMA, CA



                   By:
                      ----------------------------------------
                         Name: Sanford J. Colen
                         Title: Custodian

                   Address:       Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California 94563
                                  Facsimile #:
                                  Attention: Sanford J. Colen

                   Number of Shares: 250

                   Purchase Price:  $12,500


                                                                               8


<PAGE>   47
                   ELYSE L. COLEN, UTMA, CA



                   By:
                      ----------------------------------------
                      Name: Sanford J. Colen
                      Title: Custodian

                   Address:       Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California 94563
                                  Facsimile #:
                                  Attention: Sanford J. Colen

                   Number of Shares: 250

                   Purchase Price:  $12,500


                   SARAH KESSLER COX



                   By:
                      ----------------------------------------

                   Address:       101 South Las Palmas Avenue
                                  Los Angeles, California  90004
                                  Facsimile #:

                   Number of Shares:  500

                   Purchase Price:  $25,000


                                                                               9


<PAGE>   48
                   JOHN DAVIES



                   By:
                      ----------------------------------------


                   Address:       c/o Tyler Runnels
                                  1999 Avenue of the Stars, Suite 2530
                                  Los Angeles, California  90067
                                  Facsimile #:

                   Number of Shares:  1,250

                   Purchase Price:  $62,500


                   DIAMOND A. PARTNERS, L.P.



                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       Lawndale Capital Management, L.L.C.
                                  One Sansome Street, Suite 3900
                                  San Francisco, California 94104
                                  Facsimile #: 415-288-2323
                                  Attention:  Andrew E. Shapiro


                   Number of Shares: 2,625

                   Purchase Price:  $131,250


                                                                              10


<PAGE>   49
                   J. STEVEN EMERSON



                   By:
                      ----------------------------------------


                   Address:       Emerson Investment Group
                                  10506 Ilona Avenue, Suite 1410
                                  Los Angeles, California  90064
                                  Facsimile #:
                                  Attention: J. Steven Emerson


                   Number of Shares: 6,250

                   Purchase Price:  $312,500


                   EMILY FAIRBAIRN - IRA



                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       One Valley High
                                  Lafayette, California  94549
                                  Facsimile #:
                                  Attention: Emily Wang


                   Number of Shares: 4,500

                   Purchase Price:  $225,000


                                                                              11


<PAGE>   50
                   MALCOLM FAIRBAIRN - IRA



                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       One Valley High
                                  Lafayette, California  94549
                                  Facsimile #:
                                  Attention: Emily Wang


                   Number of Shares: 1,500

                   Purchase Price:  $75,000


                   WILLIAM T. AND KATHLEEN P. GIBSON


                   By:
                      ----------------------------------------
                         Name: William T. Gibson


                   By:
                      ----------------------------------------
                         Name: Kathleen P. Gibson


                   Address:       109 La Plata
                                  Santa Barbara, California  93109
                                  Facsimile #:


                   Number of Shares: 500

                   Purchase Price:  $25,000


                                                                              12


<PAGE>   51
                   JONATHAN & NANCY GLASER FAMILY TRUST



                   By:
                      ----------------------------------------
                         Name: Jonathan M. Glaser
                         Title:    Trustee

                   By:
                      ----------------------------------------
                         Name:  Nancy Ellen Glaser
                         Title:    Trustee

                   Address:       1999 Avenue of the Stars, Suite 2530
                                  Los Angeles, California 90067
                                  Facsimile #:
                                  Attention:


                   Number of Shares: 2,000

                   Purchase Price:  $100,000


                   EDWARD M. HAWLEY



                   By:
                      ----------------------------------------


                   Address:       129 North Van Ness
                                  Los Angeles, California  90004
                                  Facsimile #:



                   Number of Shares: 200

                   Purchase Price:  $10,000


                                                                              13


<PAGE>   52
                   GEORGE P. HAWLEY



                   By:
                      ----------------------------------------


                   Address:       116 North Citrus Avenue
                                  Los Angeles, California  90036
                                  Facsimile #: 323-939-9555

                   Number of Shares: 200

                   Purchase Price:  $10,000


                   ALLISON BOOTH HAWLEY TRUST I



                   By:
                      ----------------------------------------
                      Name:  John F. Hawley
                      Title:    Trustee



                   Address:       238 South Lorrainne
                                  Los Angeles, California  90004
                                  Facsimile #:
                                  Attention: John F. Hawley


                   Number of Shares: 2,500

                   Purchase Price:  $125,000



                                                                              14


<PAGE>   53
                   CAITLIN HALE HAWLEY TRUST I



                   By:
                      ----------------------------------------
                      Name:  John F. Hawley
                      Title:    Trustee



                   Address:       238 South Lorrainne
                                  Los Angeles, California  90004
                                  Facsimile #:
                                  Attention: John F. Hawley


                   Number of Shares: 2,500

                   Purchase Price:  $125,000


                   HAWLEY FAMILY TRUST



                   By:
                      ----------------------------------------
                      Name:  John F. Hawley
                      Title:    Trustee


                   Address:       238 South Lorrainne
                                  Los Angeles, California  90004
                                  Facsimile #:
                                  Attention: John F. Hawley


                   Number of Shares: 2,500

                   Purchase Price:  $125,000


                                                                              15


<PAGE>   54
                   MAUREEN ERIN HAWLEY TRUST I


                   By:
                      ----------------------------------------
                      Name:  John F. Hawley
                      Title:    Trustee



                   Address:       238 South Lorrainne
                                  Los Angeles, California  90004
                                  Facsimile #:
                                  Attention: John F. Hawley


                   Number of Shares: 2,500

                   Purchase Price:  $125,000


                   SHANNON FOLLEN HAWLEY TRUST I



                   By:
                      ----------------------------------------
                      Name:  John F. Hawley
                      Title:    Trustee



                   Address:       238 South Lorrainne
                                  Los Angeles, California  90004
                                  Facsimile #:
                                  Attention: John F. Hawley


                   Number of Shares: 2,500

                   Purchase Price:  $125,000


                                                                              16


<PAGE>   55
                   DR. PHILIP HAWLEY, JR.



                   By:
                      ----------------------------------------



                   Address:       165 South Las Palmas
                                  Los Angeles, California  90004-1085
                                  Facsimile #:


                   Number of Shares: 1,250

                   Purchase Price:  $62,500


                   VICTOR F. HAWLEY



                   By:
                      ----------------------------------------



                   Address:       122 South Plymouth Boulevard
                                  Los Angeles, California  90005
                                  Facsimile #: 323-931-2052


                   Number of Shares: 200

                   Purchase Price:  $10,000


                                                                              17


<PAGE>   56
                   RICHARD HICKS



                   By:
                      ----------------------------------------



                   Address:       21 Tanfield Road
                                  Tiburon, California 94920
                                  Facsimile #:


                   Number of Shares: 6,000

                   Purchase Price:  $300,000


                   IAN JACK



                   By:
                      ----------------------------------------



                   Address: 630 South Lucerne
                            Los Angeles, CA 90005


                   Number of Shares: 2,000

                   Purchase Price:  $100,000


                                                                              18


<PAGE>   57
                   KATHRYN JERGENS TRUST



                   By:
                      ----------------------------------------
                         Name:
                         Title:


                   Address:       1999 Avenue of the Stars, Suite 2530
                                  Los Angeles, California  90067
                                  Facsimile #: 310-201-2712
                                  Attention: Kathryn Jergens


                   Number of Shares: 250

                   Purchase Price:  $12,500


                   DIANE JOHNSON



                   By:
                      ----------------------------------------



                   Address: 9901 Manassas Place
                            Tucson, Arizona 85748
                            Facsimile #:


                   Number of Shares: 200

                   Purchase Price:  $10,000


                                                                              19


<PAGE>   58
                   RICHARD M. KELLER



                   By:
                      ----------------------------------------



                   Address:       101 South Las Palmas Avenue
                                  Los Angeles, California  90004
                                  Facsimile #:


                   Number of Shares: 500

                   Purchase Price:  $25,000


                   STEPHEN M. KELLER



                   By:
                      ----------------------------------------



                   Address:   30 East 81st Street, Apt. 7E
                              New York, New York 10028
                              Facsimile #:
                              Attention: Elizabeth Hughes


                   Number of Shares: 500

                   Purchase Price:  $25,000


                                                                              20


<PAGE>   59
                   STEPHEN F. KELLER PROFESSIONAL
                     CORPORATION DEFINED BENEFIT
                     PLAN



                   By:
                      ----------------------------------------
                      Name:
                      Title:   Trustee


                   Address:       101 S. Las Palmas Avenue
                                  Los Angeles, California   90004
                                  Facsimile #:
                                  Attention:  Stephen F. Keller


                   Number of Shares: 1,500

                   Purchase Price:  $75,000


                   SIDNEY KIMMEL

                   Authorized Investment Advisor:

                   By:
                      ----------------------------------------


                   Address:       Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California 94563
                                  Facsimile #:
                                  Attention: Sanford J. Colen


                   Number of Shares: 125

                   Purchase Price:  $6,250


                                                                              21


<PAGE>   60
                   KONOPISOS FAMILY TRUST DATED 12/15/80


                   By:
                      ----------------------------------------
                      Name: Theodore D. Konopisos
                      Title:    Trustee

                   By:
                      ----------------------------------------
                      Name:  Jeri L. Konopisos
                      Title:    Trustee

                   Address:       17291 Irvine Boulevard, Suite 254
                                  Tustin, California  92780
                                  Facsimile #:
                                  Attention:  Elizabeth Hughes


                   Number of Shares: 1,250

                   Purchase Price:  $62,500


                   PETER LAMM



                   By:
                      ----------------------------------------



                   Address:       1655 El Camino Real
                                  Palo Alto, California  94306
                                  Facsimile #:


                   Number of Shares: 2,000

                   Purchase Price:  $100,000


                                                                              22


<PAGE>   61
                   ROBERT LONDON



                   By:
                      ----------------------------------------



                   Address:       Cruttenden Roth
                                  809 Presidio Avenue, Suite B
                                  Santa Barbara, California  93101
                                  Facsimile #:
                                  Attention: Robert London


                   Number of Shares: 6,000

                   Purchase Price:  $300,000


                   JEFFREY S. MORGAN



                   By:
                      ----------------------------------------


                   Address:       27 Horseshoe Lane
                                  Rolling Hills Estates, CA
                                  90274
                                  Facsimile #:  310-516-2310
                                  Attention: Jeffrey S. Morgan


                   Number of Shares: 200

                   Purchase Price:  $10,000


                                                                              23


<PAGE>   62
                   JEFFREY S. MORGAN BSSC MASTER DEFINED CONTRIBUTION
                   PENSION PLAN


                   By:
                       ----------------------------------------
                   Name:
                        ---------------------------------------
                   Its:
                       ----------------------------------------

                   Address:       Bear Stearns Corp. Custodian
                                  One Metrotech Center North
                                  Brooklyn, New York
                                  11201
                                  Facsimile #: 310-516-2310
                                  Attention: Jeffrey S. Morgan

                   Number of Shares: 425

                   Purchase Price:  $21,250


                                                                              24


<PAGE>   63
                   THE MUHL FAMILY TRUST



                   By:
                      ----------------------------------------
                      Name: Phillip E. Muhl
                      Title:    Trustee


                   By:
                      ----------------------------------------
                      Name:  Kristin A. Muhl
                      Title:    Trustee



                   Address:       500 South Buena Vista
                                  Burbank, California  91521-0312
                                  Facsimile #:
                                  Attention:  Phillip E. Muhl or Kristin A.
                   Muhl


                   Number of Shares: 625

                   Purchase Price:  $31,250


                                                                              25


<PAGE>   64
                   PACIFIC SECURITY GROUP, INC.



                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       2224 Walsh Tarlton, Suite 200
                                  Austin, Texas  78746
                                  Facsimile #:


                   Number of Shares: 500

                   Purchase Price:  $25,000


                   PERMAL U.S. OPPORTUNITIES LTD.

                   Authorized Investment Advisor:

                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California 94563
                                  Facsimile #:
                                  Attention: Sanford J. Colen


                   Number of Shares: 1,000

                   Purchase Price:  $50,000


                                                                              26


<PAGE>   65
                   PILOT HOLDINGS, L.P.

                   By: SHED INVESTMENTS, LLC, its General Partner


                   By:
                      ----------------------------------------
                      Name:  Thomas M. DeLitto
                      Title: Managing Member


                   Address:     177 Post Road West
                                Westport, Connecticut 96880
                                Facsimile #: (203) 222-7187
                                Attention: Thomas M. DeLitto


                   Number of Shares: 5,000

                   Purchase Price:  $250,000


                   POINTE INVESTMENTS CAPITAL, LTD.



                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       638 N. Faring
                                  Los Angeles, California  90077
                                  Facsimile #:
                                  Attention: Mohamed Hadid


                   Number of Shares:2,000

                   Purchase Price:  $100,000


                                                                              27


<PAGE>   66
                   POLLAT, EVANS & CO., INC.

                   Authorized Investment Advisor:

                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California 94563
                                  Facsimile #:
                                  Attention: Sanford J. Colen


                   Number of Shares: 175

                   Purchase Price:  $8,750


                                                                              28


<PAGE>   67
                   KEVIN AND ERIN PRZYBOCKI



                   By:
                      ----------------------------------------
                      Name:  Kevin Przybocki

                   By:
                      ----------------------------------------
                      Name: Erin Przybocki


                   Address:       1104 Vancouver Avenue
                                  Burlingame, California 94010
                                  Facsimile #:


                   Number of Shares: 200

                   Purchase Price:  $10,000


                   CHARLES B. RUNNELS, JR.



                   By:________________________________________



                   Address:       2029 Avenue of the Stars, Suite 2530
                                  Los Angeles, California  90067
                                  Facsimile #:
                                  Attention: Tyler Runnels

                   Number of Shares: 625

                   Purchase Price:  $31,250


                                                                              29


<PAGE>   68
                   CHARLES B. RUNNELS, III



                   By:
                      ----------------------------------------



                   Address:       10095 East Charter Oak
                                  Scottsdale, Arizona 85260
                                  Facsimile #:

                   Number of Shares: 625

                   Purchase Price:  $31,250


                   G. TYLER RUNNELS



                   By:
                      ----------------------------------------



                   Address:       1999 Avenue of the Stars, Suite 2530
                                  Los Angeles, California  90067
                                  Facsimile #: 310-201-2712

                   Number of Shares: 5,600

                   Purchase Price:  $280,000


                                                                              30


<PAGE>   69
                   LORD ROBIN RUSSELL



                   By:
                      ----------------------------------------



                   Address:       Park House
                                  Woburn Park
                                  Woburn
                                  Milton Keynes
                                  MK17 9PQ England
                                  Facsimile #:


                   Number of Shares: 250

                   Purchase Price:  $12,500


                   TIMOTHY MICHAEL WALLACE



                   By:
                      ----------------------------------------



                   Address:       116 S. McCadden Place
                                  Los Angeles, California  90004
                                  Facsimile #:
                                  Attention: Tyler Runnels

                   Number of Shares: 2,500

                   Purchase Price:  $125,000


                                                                              31


<PAGE>   70
                   WAVE ENTERPRISES, INC.



                   By:
                      ----------------------------------------
                      Name:  Mike E. O'Neal
                      Title:  President

                   Address:       24255 Pacific Coast Highway
                                  Malibu, California  90263-4458
                                  Facsimile #:
                                  Attention: Mike E. O'Neal


                   Number of Shares: 250

                   Purchase Price:  $12,500


                   IRA WEINGARTEN



                   By:________________________________________


                   Address:       Equity Communications
                                  1512 Grand Avenue, Suite 200
                                  Santa Barbara, California  93103
                                  Facsimile #:
                                  Attention: Ira Weingarten

                   Number of Shares: 625

                   Purchase Price:  $31,250


                                                                              32


<PAGE>   71
                   DAVID WEINSTEIN



                   By:
                      ----------------------------------------


                   Address:       5523 Ashpon Court
                                  Boca Raton
                                  Florida  33486
                                  Facsimile #: 561-988-7913


                   Number of Shares: 400

                   Purchase Price:  $20,000


                   J.D. YATES



                   By:
                      ----------------------------------------


                   Address:       1235 Lane 30 1/4
                                  Pueblo, Colorado 81006
                                  Facsimile #:


                   Number of Shares: 250

                   Purchase Price:  $12,500


                                                                              33


<PAGE>   72
                   ZAXIS PARTNERS, L.P.



                   By:
                      ----------------------------------------
                      Name:
                      Title:

                   Address:       Apex Capital, LLC
                                  Pine Grove
                                  4 Orinda Way, Suite 240-B
                                  Orinda, California 94563
                                  Facsimile #:
                                  Attention: Sanford J. Colen


                   Number of Shares: 5,000

                   Purchase Price:  $250,000


                                                                              34

<PAGE>   73
                                    EXHIBIT A

               FORM OF AMENDED AND RESTATED STOCKHOLDERS AGREEMENT


<PAGE>   74

                                                                       EXHIBIT B


                       FORM OF MORRISON & FOERSTER OPINION


                                January [ ], 2000



[Initial Purchasers]
[Individual Purchaser]

                             Re:    Issuance of 380,000 Shares of Series A
                                    Convertible Preferred Stock of
                                    Krause's Furniture, Inc.


Ladies and Gentlemen:

               We have acted as special counsel for Krause's Furniture, Inc., a
Delaware corporation (the "Company"), in connection with the transactions
contemplated by the Series A Convertible Preferred Stock Securities Purchase
Agreement, dated as of January [ ], 2000 (the "Securities Purchase Agreement"),
among the Company and the purchasers listed on the signature pages thereto (the
"Purchasers"). This opinion is furnished to you pursuant to Section 7.2(d) of
the Securities Purchase Agreement. Unless otherwise defined herein, terms
defined in the Securities Purchase Agreement shall have the same meanings
herein.

               We have examined originals or copies of the following documents
(each a "Document" and collectively, the "Documents"):

-       the Securities Purchase Agreement;

-       the Amended and Restated Stockholders Agreement, dated as of January
        [ ], 2000, by and among the Company and the stockholders of the Company
        listed on the signature pages thereto;

-       the Amended and Restated Registration Rights Agreement, dated as of
        January [ ], 2000, by and among the Company and the stockholders of the
        Company listed on the signature pages thereto;

<PAGE>   75
[Initial Purchasers]
[Individual Purchaser]
January [  ], 2000
Page 2


-       the Agreement Amending the Supplemental Securities Purchase Agreement,
        dated as of January [ ], 2000, by and among the Company, General
        Electric Capital Corporation and Japan Omnibus Ltd.; and

-       the Certificate of Designation of Series A Convertible Preferred Stock
        of the Company filed with the Delaware Secretary of State as of January
        12, 2000.

               In addition, we have examined such records, documents,
certificates of public officials and of the Company, made such inquiries of
officials of the Company, and considered such questions of law as we have deemed
necessary for the purpose of rendering the opinions set forth herein. We have
also examined a form of certificate of the Series A Preferred Stock.

               We have assumed the genuineness of all signatures and the
authenticity of all items submitted to us as originals and the conformity with
originals of all items submitted to us as copies. In making our examination of
the Documents, we have assumed that each party to one or more of the Documents
other than the Company has the power and authority (and with respect to parties
that are individuals, the capacity) to execute and deliver, and to perform and
observe the provisions of the Documents, and has duly authorized, executed and
delivered such Documents, and that such Documents constitute the legal, valid
and binding obligations of such party.

               Our opinion in paragraph (a) below as to the qualification and
good standing of the Company and its Subsidiaries is based solely upon
certificates of public officials in the states referred to in that paragraph. In
addition, with your consent, we have relied upon the certificate of Robert
Burton, the senior vice president and chief financial officer of the Company,
and Judith O. Lasker, the secretary and general counsel of the Company (the
"Officers' Certificate") attached hereto as Exhibit A, with respect to certain
factual matters. Our opinion in paragraph (h) below is based solely upon the
Officers' Certificate and our review of the agreements and orders described
therein. We have made no independent investigation as to whether those
certificates are accurate or complete, but we have no knowledge of any such
inaccuracy or incompleteness. In rendering our opinions in paragraphs (f), (i)
and (j) below, we have assumed that the representations and warranties of the
Purchasers contained in the Securities Purchase Agreement are true and correct
as of when made and as of the date hereof, including that each Purchaser is an
"accredited investor" within the meaning of Regulation D under the Securities

<PAGE>   76
[Initial Purchasers]
[Individual Purchaser]
January [  ], 2000
Page 3


Act and that each Purchaser is acquiring the Series A Preferred Stock being
purchased by such person under the Securities Purchase Agreement for investment
purposes only and not with a view to distribution thereof.

               Our opinion in paragraph (j) below is based on a review of those
statutes and regulations which, in our experience, are normally applicable to
transactions of the type contemplated by the Documents.

               Whenever our opinion herein with respect to the existence or
absence of facts is indicated to be based on our knowledge, it is intended to
signify that, in connection with the matter described in the first paragraph
hereof, none of Charles Kaufman, Timothy Scott, Kathryn Johnstone, Michael J.
Connell, Allen Weingarten, Joseph Cuomo or Raj Tanden has acquired actual
knowledge of the existence or absence of such facts. Please be advised that the
above-named persons are the only attorneys of this firm who have been actively
engaged in the representation of the Company in connection with that matter
(although other attorneys of the firm have represented and continue to represent
the Company on other matters). We have not undertaken any independent
investigation to determine the existence or absence of such facts, and no
inference as to our knowledge of the existence or absence of such facts should
be drawn from the fact of our representation of the Company.

               We express no opinion herein relating to state securities or blue
sky laws. We express no opinion herein as to the Supplemental Securities
Purchase Agreement, dated as of August 14, 1997.

               The opinions hereinafter expressed are subject to the following
further qualifications and exceptions:

        (1)    The effect of bankruptcy, insolvency, reorganization,
               arrangement, moratorium or other similar laws relating to or
               affecting the rights of creditors generally, including, without
               limitation, laws relating to fraudulent transfers or conveyances,
               preferences and equitable subordination;

        (2)    Limitations imposed by general principles of equity upon the
               availability of equitable remedies or the enforcement of
               provisions of the Documents, and the effect of judicial decisions
               which have held that certain provisions are unenforceable where
               their enforcement would violate the implied covenant of good
               faith and fair dealing, or would be commercially unreasonable or
               where a default under the Documents is not material;

<PAGE>   77
[Initial Purchasers]
[Individual Purchaser]
January [  ], 2000
Page 4


        (3)    The effect of judicial decisions which may permit the
               introduction of extrinsic evidence to supplement the terms of the
               Documents or to aid in the interpretation of the Documents;

        (4)    We express no opinion as to the effect on the opinions expressed
               herein of (i) the compliance or non-compliance of any party to
               the Documents other than the Company with any laws or regulations
               applicable to it, or (ii) the legal or regulatory status or the
               nature of the business of any such party;

        (5)    We express no opinion as to the enforceability of provisions of
               the Documents providing for indemnification or contribution, to
               the extent such indemnification or contribution is against public
               policy;

        (6)    We express no opinion as to the enforceability of the provisions
               of Section 4.7 of the Securities Purchase Agreement insofar as
               such provisions are required to be stated in the Certificate of
               Incorporation of the Company to be valid and binding obligations
               of the Company; and

        (7)    We express no opinion as to the enforceability of any provisions
               of the Documents providing that claims arising under the
               Documents are to be determined by a particular court or
               particular courts.

               Based upon and subject to the foregoing, we are of the opinion
               that:

               (a) The Company is a corporation duly organized, validly existing
and in good standing under the laws of the State of Delaware and is duly
qualified and in good standing in the State of California. Each of Keegan
Management Co., Krause's Custom Crafted Furniture, Castro Convertible Corp. and
Brea Holdings, Inc. (the "Subsidiaries") is a corporation duly incorporated,
validly existing and in good standing under the laws of the jurisdiction in
which it is incorporated.

               (b) The Company has the corporate power and authority to execute
and deliver, and to perform and observe the provisions of, the Documents.

<PAGE>   78
[Initial Purchasers]
[Individual Purchaser]
January [  ], 2000
Page 5


               (c) The Documents have each been duly authorized, executed and
delivered by the Company. The Documents constitute valid and binding obligations
of the Company enforceable against the Company in accordance with their
respective terms.

               (d) The shares of Series A Preferred Stock have been duly
authorized and are validly issued, fully paid and nonassessable.

               (e) Following receipt of the requisite approval of the Company's
stockholders and the filing with the Delaware Secretary of State of an amendment
to the Company's Certificate of Incorporation effecting the requisite increase
in the Company's authorized shares of Common Stock, the shares of Common Stock
issuable upon conversion of the Series A Preferred Stock, when issued and
delivered upon conversion in accordance with the terms of the Certificate of
Designation, will be validly issued, fully paid and nonassessable.

               (f) No registration with, consent or approval of, notice to, or
other action by, any governmental entity is required on the part of the Company
for the execution, delivery or performance by the Company of the Documents, or
if required, such registration has been made, such consent or approval has been
obtained, such notice has been given or such other appropriate action has been
taken, except for any filings required pursuant to state and federal securities
laws which will be timely if made after the Closing Date.

               (g) The execution, delivery and performance of the Documents by
the Company are not in violation of its Certificate of Incorporation or Bylaws.

               (h) The execution, delivery and performance of the Documents by
the Company will not violate or result in a material breach of any of the terms
of or constitute a material default under or (except as contemplated in the
Documents) result in the creation of any lien, charge or encumbrance on any
property or assets of the Company, pursuant to the terms of any indenture,
mortgage, deed of trust or other agreement or order described in the Officers'
Certificate. As to agreements which by their terms are or may be governed by the
laws of a jurisdiction other than California or New York, we assume that such
agreements are governed by the law of California for purposes of the opinion
expressed in this paragraph. In addition, we exclude from the scope of such
opinion any potential violation of financial covenants contained in such
agreements.

<PAGE>   79
[Initial Purchasers]
[Individual Purchaser]
January [  ], 2000
Page 6


               (i) It is not necessary to register under the Securities Act of
1933, as amended, the offer, sale or delivery by the Company to the Purchasers
of the Series A Convertible preferred Stock, or the issuance to the holders of
the Series A Convertible Preferred Stock of the Common Stock to be issued upon
the conversion thereof in the manner contemplated by the Securities Purchase
Agreement and the Certificate of Designation.

               (j) The sale and issuance of the shares of Series A Convertible
Preferred Stock in accordance with the terms of the Securities Purchase
Agreement will not violate any federal, New York or California statute
applicable to the Company, or the General Corporation Law of the State of
Delaware.

               We express no opinion as to matters governed by any laws other
than the substantive laws of the States of New York (including its applicable
choice-of-law rules) and California, the General Corporation Law of the State of
Delaware and the federal laws of the United States, in each case which are in
effect on the date hereof.

               We note that each Document other than the Certificate of
Designation contains a New York choice-of-law provision. We have assumed, with
your permission, that any provision of the Documents excepting New York choice
or conflicts of law rules from any New York choice-of-law provision would not be
interpreted to include Section 5-1401 of the General Obligations Law of the
State of New York ("NYGOL"). We express no opinion as to the New York
choice-of-law provision in each of the Documents to the extent that Section
1-105 of the Uniform Commercial Code of the State of New York requires the
application of the law of another jurisdiction. For purposes of this opinion, we
have assumed that Section 5-1401 of NYGOL would be given effect in accordance
with its terms. We have assumed that no provision of the Documents violates the
public policy of any jurisdiction other than the State of New York having a
substantial relationship to the transaction contemplated by the Documents, and
that no provision of the law of the State of New York applicable to the
Documents violates the public policy of any such other jurisdiction. We express
no opinion as to the effect of the laws of any jurisdiction other than the State
of New York on the opinions expressed herein regarding the enforceability of New
York choice-of-law provisions.

<PAGE>   80
[Initial Purchasers]
[Individual Purchaser]
January [  ], 2000
Page 7


               This opinion is solely for your benefit and may not be relied
upon by, nor may copies be delivered to, any other person without our prior
written consent.

                                            Very truly yours,

<PAGE>   81

                                                            Exhibit A to Opinion


                              OFFICERS' CERTIFICATE
                            Krause's Furniture, Inc.

               IN CONNECTION WITH the execution and delivery by KRAUSE'S
FURNITURE, INC., a Delaware corporation (the "COMPANY"), of a Series A
Convertible Preferred Stock Securities Purchase Agreement dated as of January
___, 2000 (the "SECURITIES PURCHASE AGREEMENT") among the Company and the
purchasers listed on the signature pages thereto (collectively, the
"PURCHASERS"), Morrison & Foerster, LLP has been asked to render its opinion
with respect to various matters (the "OPINION LETTER").

               In support of the Opinion Letter and with the knowledge that
Morrison & Foerster, LLP is relying on the matters hereby certified in rendering
certain portions of the Opinion Letter, the undersigned hereby certify that the
undersigned are the duly elected and acting Chief Financial Officer and
Secretary of the Company and, as of the date hereof:

        1. Attached hereto as EXHIBIT A is a true and correct copy of the
Certificate of Incorporation of the Company, as on file with the Secretary of
State of the State of Delaware (the "CERTIFICATE"). Except as reflected in
EXHIBIT A, the Certificate has not been modified, amended or superseded, and
remains in full force and effect.

        2. Attached hereto as EXHIBIT B is a true, correct and complete copy of
the Bylaws of the Company as modified or amended through and including the date
hereof, and such Bylaws have not otherwise been modified, amended or superseded,
and the Bylaws remain in full force and effect.

        3. Attached hereto as EXHIBIT C is a true, correct and complete copy of
the resolutions duly adopted by the Board of Directors of the Company at a
meeting duly noticed and held on December 29, 1999. All such resolutions are in
full force and effect on the date hereof and in the form in which adopted and no
other resolutions have been adopted by the Board of Directors of the Company or
any committee thereof relating to the transaction referred to in such
resolutions or with respect to any amendment or modification to the Certificate
or the Bylaws of the Company.

        4. Attached hereto as EXHIBIT D is a schedule of material contracts and
obligations of the Company as of the date hereof for purposes of the Opinion
Letter.

<PAGE>   82

        5. The following named individuals are elected officers of the Company,
each holding the office of the Company set forth opposite their respective name.
The signature written opposite the name and title of each such officer is in
each case such person's genuine signature.


<TABLE>
<CAPTION>
Name                  Office                              Signature
----                  ------                              ---------
<S>                   <C>                                 <C>
Philip M. Hawley      Chairman of the Board and
                      Chief Executive Officer

Robert A. Burton      Senior Vice President and
                      Chief Financial Officer

Judith Olson Lasker   Secretary and General
                      Counsel
</TABLE>

        6. No certificate relating to the voluntary or involuntary dissolution
of the Company, and no certificate of merger of the Company, has been or is
being held for subsequent filing with the Secretary of State of Delaware.
Further, no event leading to any dissolution or merger of the Company has
occurred and the Company is validly existing and in good standing under the laws
of the State of Delaware.

        7. The Company has no permit, authorization, concession, franchise or
license that is important to the conduct of the business of the Company which is
not of a type commonly obtained by businesses generally or by businesses in a
similar line of business.

        8. As used herein, "BANKRUPTCY CODE" shall mean the Bankruptcy Code of
1978, 11 U.S.C. 101 et seq., as amended and now in effect and as hereafter
amended. The Company has not: (i) filed a voluntary petition or answer seeking
liquidation, reorganization, arrangement, readjustment of its debts, or for any
other relief under the Bankruptcy Code, or under any other act or law pertaining
to insolvency or debtor relief, whether state, Federal, or foreign; (ii) entered
into any agreement indicating its consent to, approval of, or acquiescence in,
any such petition or proceeding; (iii) applied for, or acquiesced in any
application for, the appointment of a receiver, custodian or trustee for the
Company or for all or a substantial part of its property; (iv) made an
assignment for the benefit of creditors, or admitted any inability or failure
generally to pay its debts as such debts become due.

<PAGE>   83

        9. The Company has not received any notice of: (i) any filing of an
involuntary petition against the Company seeking liquidation, reorganization,
arrangement or readjustment of its debts, or for any other relief under the
Bankruptcy Code, or under any other act or law pertaining to insolvency or
debtor relief, whether state, Federal or foreign; (ii) the involuntary
appointment of a receiver, custodian or trustee of the Company or for all or a
substantial part of the Company's property; or (iii) the entry of a material
judgment or the issuance of a writ of attachment, execution or similar process
against any substantial part of the property of the Company, or the entry of an
order for relief under the Bankruptcy Code or any other applicable act or law,
in any such case or proceeding.

        10. Neither the Company nor its assets is subject to any order, writ,
judgment, injunction, decree, determination or award of any court or of any
governmental agency or instrumentality (whether federal, state, local or
foreign) that affects the Company's business operations, restricts its business
or restricts its freedom to contract. To our knowledge, no authorization,
approval, consent or other order of, or registration, qualification, declaration
or filing with, any governmental agency, court or any other entity is required
for the authorization, execution, delivery or performance by the Company of the
Securities Purchase Agreement or any instrument or agreement to be executed or
delivered by the Company as contemplated therein, and the Company is not
required to notify any governmental authority or agency of the United States or
the State of Delaware, including any court of law, of any transactions or
agreements that it enters into or obligations it undertakes.

        11. To our knowledge, the execution, delivery and performance by the
Company of the Securities Purchase Agreement and any instrument or agreement to
be executed or delivered by the Company as contemplated therein, will not
violate or result in a material breach of any of the terms of or constitute a
material default under or (except as contemplated in the Documents) result in
the creation of any lien, charge or encumbrance on any property or assets of the
Company pursuant to the terms of any indenture, mortgage, deed of trust or other
agreement or order described in EXHIBIT D attached hereto.

        12. The Company has not offered the Series A Preferred Stock to any
person who is not an "accredited investor," as defined in Regulation D under the
Securities Act of 1933, as amended.

                      [the next page is the signature page]

<PAGE>   84

               IN WITNESS WHEREOF, the undersigned have executed this Officer's
Certificate of as of January ____, 2000.



                                             -----------------------------------
                                             ROBERT A. BURTON,
                                             Senior Vice President and Chief
                                             Financial Officer



                                             -----------------------------------
                                             JUDITH OLSON LASKER,
                                             Secretary and General Counsel

<PAGE>   85

                                    EXHIBIT C

                   FORM OF AMENDED AND RESTATED REGISTRATION
                                RIGHTS AGREEMENT


<PAGE>   86

                                    EXHIBIT D

                         FORM OF INDEBTEDNESS AMENDMENT
<PAGE>   87

                                  SCHEDULE 6.1

                                EVENTS OF DEFAULT


                (a) the Company's breach of the covenant contained in the last
        sentence of Section 4.13 of the Agreement;

                (b) the failure of the Company to receive approval of the
        E-Commerce Plan in accordance with Section 2.2(u) of the Stockholders
        Agreement within 120 days from the First Closing Date;

                (c) failure to use at least $10,000,000 of the Proceeds for
        E-Commerce Proceed Uses during the term of the E-Commerce Plan; and

                (d) the Company's material variance (positive or negative) from
        the aggregate projected expenditures contained in the E-Commerce Plan
        for any calendar month and the continuance of a material variance for
        the period beginning on the first day of such month and ending 60 days
        after written notice is given to the Company by THLi.

        THLi shall be deemed to waive any Event of Default pursuant to clause
(c) or (d) above unless THLi has notified the Company in writing of such Event
of Default within 15 days of the later of (i) THLi's becoming aware of such
Event of Default and (ii) THLi's receipt of the monthly report required by
Section 4.9(e) of the Agreement. In addition, THLi may approve deviations from
the E-Commerce Plan (and such deviations will not be deemed to be Events of
Default) or waive any of the defaults listed above, in each case by executing a
written instrument specifying such waiver.



                                 Schedule 6.1 - 1