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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

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<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
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<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
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<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

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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<PAGE>   1
                                                                   EXHIBIT 10.17

                   AMENDED AND RESTATED STOCKHOLDERS AGREEMENT

                                  by and among

                            KRAUSE'S FURNITURE, INC.

                                       and

                           THE STOCKHOLDERS LISTED ON

                           THE SIGNATURE PAGES HEREOF

                          Dated as of January 14, 2000

<PAGE>   2

                                 TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                PAGE
<S>                 <C>                                                         <C>
        Section 1.  Definitions...................................................2

        Section 2.  Corporate Governance..........................................8
               2.1  Board of Directors............................................8
               2.2  Certain Actions Requiring Consent of the GECC Designee
                    and the THLi Fund Designee...................................11
               2.3  Management...................................................14
               2.4  Directors'  Indemnification..................................15
               2.5  Expenses.....................................................15
               2.6  Cooperation..................................................16

        Section 3.  Restrictions on Transfers of Stock...........................16

        Section 4.  Rights of First Offer........................................16

        Section 4A.  Hawley Trust Stock Rights of First Offer....................18

        Section 5.  Tag-Along Rights.............................................20

        Section 6.  Conflicting Agreements.......................................21

        Section 7.  Legend.......................................................21

        Section 8.  Representations and Warranties...............................22

        Section 9.  Duration of Agreement........................................23

        Section 10.  Further Assurances..........................................24

        Section 11.  Amendment and Waiver........................................24

        Section 12.  Severability................................................24

        Section 13.  Entire Agreement............................................24
</TABLE>

                                        -i-

<PAGE>   3

<TABLE>
<S>                  <C>                                                        <C>
        Section 14.  Successors and Assigns......................................24

        Section 15.  Counterparts................................................25

        Section 16.  Remedies....................................................25

        Section 17.  Notices and Other Communications............................25

        Section 18.  Governing Law; Consent to Jurisdiction......................27

        Section 19.  Descriptive Headings........................................27

        Section 20.  Construction................................................28
</TABLE>

                                       -ii-

<PAGE>   4

                   AMENDED AND RESTATED STOCKHOLDERS AGREEMENT

        This Amended and Restated Stockholders Agreement (this "Agreement") is
made as of January 14, 2000 by and among Krause's Furniture, Inc., a Delaware
corporation (the "Company") and each of the stockholders of the Company listed
on the signature pages hereof (each, a "Signatory Stockholder" and collectively,
the "Signatory Stockholders").

                               W I T N E S S E T H :

        WHEREAS, pursuant to a Securities Purchase Agreement between the Company
and General Electric Capital Corporation (collectively, with GE Capital Equity
Investments, Inc., "GECC") dated August 26, 1996 (the "1996 Securities Purchase
Agreement"), GECC purchased from the Company 5,000,000 shares of the Company's
common stock, par value $.001 per share (the "Common Stock"), for an aggregate
purchase price of $5,000,000, the Company's 10% Subordinated Pay-in-Kind Notes
due August 31, 2001, as described in the Securities Purchase Agreement (the
"Notes"), in the initial principal amount of $5,000,000, and, in connection with
the Notes, a warrant (the "First Warrant") to purchase 1,400,000 shares of
Common Stock;

        WHEREAS, concurrently with such purchase by GECC, (i) Hawley Group
purchased 1,000,000 shares of Common Stock for an aggregate purchase price of
$1,000,000, (ii) certain other investors purchased 3,000,000 shares of Common
Stock for an aggregate purchase price of $3,000,000 and (iii) Japan Omnibus Ltd.
(formerly named Edson Investments Inc.) and certain other holders of
indebtedness of the Company exchanged such indebtedness for shares of Common
Stock, as more fully described in the Securities Purchase Agreement;

        WHEREAS, in connection with the 1996 Securities Purchase Agreement, the
Company entered into a Stockholders Agreement with certain stockholders dated
August 26, 1996 (the "Prior Stockholders Agreement");

        WHEREAS, pursuant to a Supplemental Securities Purchase Agreement
between the Company, GECC and Japan Omnibus LTD. ("JOL"), dated August 14, 1997,
(i) the Company and GECC amended and restated the provisions of the Notes, (ii)
GECC and JOL purchased certain additional notes, (iii) in connection with the
Notes, GECC and JOL received warrants (the "Second Warrants") to purchase
1,300,000 shares of Common Stock and (iv) GECC and JOL received an additional

                                         1

<PAGE>   5

warrant (the "Performance Warrant," and collectively with the First Warrant and
the Second Warrants, the "Warrants") to purchase 1,000,000 shares of Common
Stock;

        WHEREAS, pursuant to a Securities Purchase Agreement among the Company,
TH Lee.Putnam Internet Partners, L.P. and TH Lee.Putnam Internet Parallel
Partners, L.P. (collectively with their Affiliates, "THLi"), and the purchasers
listed on the signature pages thereto (collectively, the "Purchasers"), dated
the date hereof (the "2000 Securities Purchase Agreement," and, together with
the 1996 Securities Purchase Agreement, the "Securities Purchase Agreements"),
the Purchasers are purchasing from the Company 380,000 shares of the Company's
Series A Convertible Preferred Stock, par value $.001 per share (the "Series A
Preferred Stock"), for an aggregate purchase price of $19,000,000;

        WHEREAS, pursuant to the 2000 Securities Purchase Agreement, the Company
will restructure the Notes, as more fully described in the 2000 Securities
Purchase Agreement; and

        WHEREAS, it is a condition to the consummation of the foregoing
transactions that the parties hereto enter into this Agreement to amend, restate
and supersede the Prior Stockholders Agreement in accordance with Section 11 of
the Prior Stockholders Agreement, and the parties hereto deem it to be in their
best interests to enter into this Agreement establishing and setting forth their
agreement with respect to certain rights and obligations associated with
ownership of shares of capital stock of the Company.

        SECTION 1. DEFINITIONS. As used herein, the following terms shall have
the following meanings (capitalized terms used herein and not defined herein
shall have the meanings assigned to such terms in the 2000 Securities Purchase
Agreement):

        "Affiliate" and "Associate" have the 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 securities shall mean having
"beneficial ownership" of such securities (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" has the meaning assigned to it in Section 2.1.

                                         2

<PAGE>   6

        "By-laws" means the By-laws of the Company as in effect on the date
hereof, as they may be amended from time to time hereafter.

        "Capitalized Lease" shall mean, with respect to any person, any lease or
any other agreement for the use of property which, in accordance with generally
accepted accounting principals, should be capitalized on the lessee's or user's
balance sheet.

        "Capitalized Lease Obligation" of any person shall mean and include, as
of any date as of which the amount thereof is to be determined, the amount of
the liability capitalized or disclosed (or which should be disclosed) in a
balance sheet of such person in respect of a Capitalized Lease of such person.

        "Certificate" means the Certificate of Incorporation of the Company as
in effect on the date stated hereof, as it may be amended from time to time
hereafter.

        "Common Stock Equivalents" means rights, options, scrip, warrants or
other securities convertible into, or exchangeable or exercisable for, shares of
Common Stock.

        "Company" has the meaning assigned to it in the first paragraph hereof.

        "Current Market Price", when used with reference to shares of Common
Stock for any given date, shall mean the closing price per share of Common Stock
on such date. The closing price for each day shall be the last quoted sale price
or, if not so quoted, the average of the high bid and low asked prices in the
over-the-counter market, as reported by the National Association of Securities
Dealers, Inc. Automated Quotation System or such other system then in use, or,
if on any such date the Common Stock or such other securities are not quoted by
any such organization, the average of the closing bid and asked prices as
furnished by a professional market maker making a market in the Common Stock or
such other securities selected by the Board of Directors of the Company. If the
Common Stock is listed or admitted to trading on a national securities exchange,
the closing price shall be the last sale price, regular way, or, in case no such
sale takes place on such day, the average of the closing bid and asked prices,
regular way, in either case as reported in the principal consolidated
transaction reporting system with respect to securities listed or admitted to
trading on the New York Stock Exchange or, if the Common Stock or such other
securities are not listed or admitted to trading on the New York Stock Exchange,
as reported in the principal consolidated transaction reporting system with
respect to

                                         3

<PAGE>   7

securities listed on the principal national securities exchange on which the
Common Stock or such other securities are listed or admitted to trading.

        "E-Commerce Activities" shall mean business-to-business and e-commerce
activities, including commerce related to transactions on the Internet, related
to the E-Commerce Proceed Uses.

        "Employment Agreement" shall mean the Employment Agreement dated as
of August 26, 1996, as amended, between the Company and Philip M. Hawley
("Hawley").

        "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended, or any successor Federal statute, and the rules and regulations of the
omission 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.

        "Fully Diluted" shall mean, when used with reference to the Common
Stock, at any date as of which the number of shares thereof is to be determined,
(i) all shares of Common Stock outstanding at such date and (ii) all shares of
Common Stock issuable in respect of vested options or warrants to purchase, or
securities convertible into, exercisable for or exchangeable for, shares of
Common Stock outstanding on such date, the conversion, exercise or exchange
price of which is less than the Current Market Price.

        "Group" has the meaning assigned such term for purposes of Rule 13d-5
under the Exchange Act.

        "Guarantee" by any Person shall mean all obligations (other than
endorsements in the ordinary course of business of negotiable instruments for
deposit or collection) of any Person guaranteeing, or in effect guaranteeing,
any Indebtedness, dividend or other obligation of any other Person (the "Primary
Obligor") in any manner, whether directly or indirectly, including, without
limitation, all obligations incurred through an agreement, contingent or
otherwise, by such Person: (i) to purchase such Indebtedness or obligation or
any property or assets constituting security therefor, (ii) to advance or supply
funds (x) for the purchase or payment of such Indebtedness or obligation, (y) to
maintain working capital or other balance sheet condition or otherwise to
advance or make available funds for the purchase or payment of such Indebtedness
or obligation, (iii) to lease property or to purchase

                                         4

<PAGE>   8

securities or other property or services primarily for the purpose of assuring
the owner of such Indebtedness or obligation of the ability of the primary
obligor to make payment of such Indebtedness or obligation, or (iv) otherwise to
assure the owner of the Indebtedness or obligation of the primary obligor
against loss in respect thereof. For the purposes of any computations made under
this Agreement, a Guarantee in respect of any Indebtedness for borrowed money
shall be deemed to be Indebtedness equal to the principal amount of the
Indebtedness for borrowed money which has been guaranteed, and a Guarantee in
respect of any other obligation or liability or any dividend shall be deemed to
be Indebtedness equal to the maximum aggregate amount of such obligation,
liability or dividend.

        "Hawley Group" shall mean those Persons listed on Schedule A attached
hereto.

        "Hawley Trusts" shall mean the Hawley Group other than Philip M. Hawley
and Dr. Philip M. Hawley, Jr.

        "Indebtedness" shall mean, with respect to any person, (i) all
obligations of such person for borrowed money, or with respect to deposits or
advances of any kind, (ii) all obligations of such person evidenced by bonds,
debentures, notes or similar instruments, (iii) all obligations of such person
under conditional sale or other title retention agreements relating to property
purchased by such person, (iv) all obligations of such person issued or assumed
as the deferred purchase price of property or services (other than accounts
payable to suppliers and similar accrued liabilities incurred in the ordinary
course of business and paid in a manner consistent with industry practice), (v)
all Indebtedness of others secured by (or for which the holder of such
Indebtedness has an existing right, contingent or otherwise, to be secured by)
any lien or security interest on property owned or acquired by such person
whether or not the obligations secured thereby have been assumed, but only to
the extent of such security, if such obligations have not been assumed, (vi) all
Capitalized Lease Obligations of such person, (vii) all Guarantees of such
person, (viii) all obligations (including but not limited to reimbursement
obligations) relating to the issuance of letters of credit for the account of
such person, (ix) all obligations arising out of foreign exchange contracts, and
(x) all obligations arising out of interest rate and currency swap agreements,
cap, floor and collar agreements, interest rate insurance, currency spot and
forward contracts and other agreements or arrangements designed to provide
protection against fluctuations in interest or currency exchange rates.

                                         5

<PAGE>   9

        "Permal Group" shall mean those Persons listed on Schedule C attached
hereto.

        "Permitted Transfer" shall mean any Transfer (i) by an individual Stock
holder to such Stockholder's spouse, former spouse, child, parent, parent of a
spouse, sibling or grandchild (collectively, "Relatives") or to or among a trust
of which there are no principal beneficiaries other than one or more Relatives
of such Stockholder; (ii) from a Relative of an individual Stockholder to
another Relative of that individual Stockholder or to that individual
Stockholder; (iii) by any Stockholder to any of its Affiliates or partners; or
(iv) by an Individual Stockholder pursuant to laws of descent or survivorship.

        "Person" means any individual, corporation, limited liability company,
limited or general partnership, joint venture, association, joint-stock company,
trust, unincorporated organization or government or any agency or political
subdivisions thereof.

        "Proportionate Share" means, with respect to each Stockholder, a number
of shares of Common Stock which bears the same ratio to the number of shares of
Common Stock beneficially owned by such Stockholder on a Fully Diluted basis as
the Tag-Along Number bears to the number of shares of Common Stock beneficially
owned by the Selling Stockholders on a Fully Diluted basis.

        "Registration Rights Agreement" means the Registration Rights Agreement,
dated as of the date hereof, between the Company and the stockholders listed on
the signature page thereto as it may be amended from time to time.

        "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 Relative 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.

        "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.

        "Sell" as to any Stock, shall mean to sell, or in any other way directly
or indirectly transfer (including by operation of law, by merger or
consolidation, or sale of securities of a holding company), assign, distribute
or otherwise dispose of, such

                                         6

<PAGE>   10

Stock; and the terms "Sale" and "Sold" shall have meanings correlative to the
foregoing. A Permitted Transfer shall not constitute a Sale for purposes of this
Agreement.

        "Stock" means (i) any shares of Common Stock and (ii) any Common Stock
Equivalents (including, without limitation, the Common Stock issuable upon
conversion, exercise or exchange thereof), in each case, whether owned on the
date hereof or acquired hereafter.

        "Stockholder" and "Stockholders" shall mean the stockholders listed on
Schedule B hereto; provided that any transferee of Stock pursuant to a Permitted
Transfer shall be treated as a Stockholder for purposes of this Agreement and
shall be entitled to the benefits of, and shall be bound by, the provisions of
this Agreement.

        "Stockholder's Group" shall mean, with respect to any Stockholder who is
a member of the Hawley Group or the Permal Group, either the Hawley Group or the
Permal Group, as the case may be.

        "Subsidiary" means with respect to any Person, (i) any corporation,
partnership or other entity of which shares of capital stock or other ownership
interests having ordinary voting power to elect a majority of the board of
directors or other similar managing body of such corporation, partnership or
other entity are at the time owned by such Person, or (ii) the management of
which is otherwise controlled, directly or indirectly, through one or more
intermediaries by such Person.

        "Transfer" as to any Stock, means to Sell, or in any other way directly
or indirectly transfer, assign, distribute, pledge, encumber or otherwise
dispose of, either voluntarily or involuntarily, and whether or not for value.

        "Voting Shares" means shares of any class of capital stock of the
Company the holders of which are generally entitled to vote in the election of
members of the Board.

        SECTION 2.  CORPORATE GOVERNANCE.

        2.1    BOARD OF DIRECTORS.

                                         7

<PAGE>   11

               (a) Members. Subject to the provisions of Section 6.10 of the
1996 Securities Purchase Agreement and Section 4.7 of the 2000 Securities
Purchase Agreement, the Board of Directors of the Company (the "Board") shall
consist of nine members, of whom:

               (i) one shall be designated by GECC (such person so designated,
        and any successor thereto, being referred to herein as the "GECC
        Designee");

               (ii) one shall be designated by Permal Group (such person so
        designated, and any successor thereto, being referred to herein as the
        "Permal Designee");

               (iii) one shall be Hawley, or, in the event of death or
        incapacity of Hawley, shall be John Hawley, or, if John Hawley is
        unavailable to serve as director or ceases to serve as director, then an
        individual nominated by the trustee(s) of the Hawley Trusts, having
        qualifications similar to those of John Hawley or any other director of
        the Company shall serve as director under the same terms that would have
        applied to John Hawley hereunder (the "Hawley Designee").

               (iv) an E-commerce and/or business to business expert shall be
        designated by THLi (the "THLi Internet Designee") and one additional
        member shall be designated by THLi (the "THLi Fund Designee" and,
        together with the THLi Internet Designee and any successors to either of
        them, being referred to herein as the "THLi Designees" );

               (v) one shall be unanimously designated by GECC and THLi (such
        person so designated, and any successor thereto, being referred to
        herein as the "GECC/THLi Designee"); and

               (vi) three shall be selected by the vote of the GECC Designee,
        the Permal Designee, the THLi Fund Designee and the Hawley Designee
        (such persons so designated, any successors thereto, being referred to
        herein as the "Joint Designees" and, together with the GECC Designee,
        the Permal Designee, the Hawley Designee, the THLi Designees and the
        GECC/THLi Designee, the "Designees").

        At each meeting of the stockholders of the Company held for the purpose
of electing directors, the Stockholders (other than the Hawley Trusts) shall
take such

                                         8

<PAGE>   12

action as shall be necessary to cause the Designees (or any successor to any
such person designated in accordance with paragraph (b) of this Section) to be
elected as directors (including, in the case of GECC, Permal Group and THLi,
causing their respective designees on the Board to nominate, and recommend to
the stockholders of the Company the election of, the Designees to the Board and
opposing, and causing their respective designees on the Board to oppose, any
proposal to remove any Designee at each meeting of the stockholders of the
Company at which the election or removal of members of the Board is on the
agenda), and shall take no action which would diminish the prospects of any
Designee being elected to the Board or increase the prospects of any Designee
being removed from the Board. The Company shall take all necessary action to
reduce the size of the Board to the extent required by the first sentence of
this paragraph and shall cause the current members of the Board to resign from
office as necessary to implement the provisions of the first sentence of this
paragraph.

               (b) Vacancies. Each of the GECC Designee, the Permal Designee,
the THLi Designees and the GECC/THLi Designee shall hold office until his death,
resignation or removal or until his successor shall have been duly elected and
qualified. If any GECC Designee shall cease to serve as a director of the
Company for any reason, the vacancy resulting thereby shall be filled by another
person designated by GECC. If any Permal Designee shall cease to serve as a
director of the Company for any reason, the vacancy resulting thereby shall be
filled by another person designated by Permal Group. If any of the THLi
Designees shall cease to serve as a director of the Company for any reason, the
vacancy resulting thereby shall be filled by another person designated by THLi.
If any GECC/THLi Designee shall cease to serve as a director of the Company for
any reason, the vacancy resulting thereby shall be filled by another person
unanimously designated by GECC and THLi. If the Hawley Designee shall cease to
serve as a director of the Company for any reason, the vacancy resulting thereby
shall be filled by another person unanimously designated by the Hawley Group. In
the event that at any time there exist vacancies on the Board such that there is
either no GECC Designee, no Permal Designee, no GECC/THLi Designee or less than
two THLi Designees, no action may be taken by the Board until such vacancy is
filled. GECC, Permal Group, the Hawley Group and THLi agree to use their best
efforts to designate successors to fill any such vacancies as promptly as
practicable.

               (c) Removal. No GECC Designee may be removed from office except
by GECC, no Permal Designee may be removed from office except by Permal Group,
no THLi Designee may be removed from office except by THLi, no Hawley

                                         9

<PAGE>   13

Designee may be removed from office except by the Hawley Group; provided that
such limitation shall not apply to the removal of Hawley as Chairman so long as
Hawley remains a Director, no GECC/THLi Designee may be removed from office
except unanimously by GECC and THLi. GECC shall have the right to remove any
GECC Designee, Permal Group shall have the right to remove any Permal Designee,
THLi shall have the right to remove any THLi Designee, the Hawley Group shall
have the right to remove any Hawley Designee and GECC and THLi shall
unanimously have the right to remove any GECC/THLi Designee, with or without
cause, at any time.

               (d) Quorum Requirements. Subject to Section 2.2, the quorum which
shall be required for action to be taken by the Board (other than an adjournment
of any meeting of the Board) shall be the GECC Designee, the Permal Designee,
the THLi Fund Designee and the Hawley Designee. Directors participating by
telephone conference in any meeting of the Board shall be considered in
determining whether a quorum of directors is present.

               (e) Committees. The Company shall cause the GECC Designee, the
Permal Designee and at least one THLi Designee to be appointed to each of the
committees of the Board as may be requested at any time or from time to time by
GECC, Permal Group or THLi, as the case may be.

               (f) Chairman of the Board. Hawley shall serve as Chairman of the
Board for as long as he is Chief Executive Officer. GECC, Permal Group and THLi
presently intend to continue to nominate Hawley to serve as a director and
Chairman of the Board after Hawley retires as Chief Executive Officer, provided
that Hawley shall not be obligated to accept such nomination.

               (g) Board and Committee Meetings. The Company shall hold regular
meetings of its Board on at least a quarterly basis. The Company agrees, and
shall cause its By-laws to be amended to the extent necessary to provide, that
the GECC Designee, any THLi Designee and the GECC/THLi Designee shall have the
right, upon reasonable notice, to call meetings of the Board and of each
committee of the Board on which he or she is a member.

               (h) Duration. The right of each of GECC, Permal Group and THLi to
designate directors pursuant to this Section shall continue only for so long as
GECC and its Affiliates, Permal Group, or THLi and its Affiliates, as the case
may be, beneficially owns at least 2,000,000 shares of Common Stock on a Fully
Diluted

                                        10

<PAGE>   14

Basis, as adjusted for stock splits, combinations or similar transactions. The
right of the Hawley Group to designate directors pursuant to this Section 2.1(h)
shall continue only for so long as the Hawley Group beneficially owns at least
1,000,000 shares of Common Stock on a Fully Diluted Basis, as adjusted for stock
splits, combinations or similar transactions.

               (i) Observation. In addition to THLi's right to designate members
of the Board pursuant to Section 2.1(a), so long as THLi is the owner of any
Stock, it shall have the right to designate an observer to attend meetings of
the Board, but such observer shall not have a vote with respect to any matter
presented to the Board of Directors for action thereon. In connection with such
observer's right, THLi shall receive all notices and information provided to
Board members.

        2.2 CERTAIN ACTIONS REQUIRING CONSENT OF THE GECC DESIGNEE AND THE THLI
FUND DESIGNEE. Notwithstanding any other provision of this Agreement, without
the approval, at a meeting of the Board or a committee thereof duly called and
held, (1) for so long as GECC is entitled to designate the GECC Designee, of the
GECC Designee and (2) for so long as THLi is entitled to designate the THLi Fund
Designee, of the THLi Fund Designee, the Company shall not, directly or
indirectly, and shall not permit any of its Subsidiaries to, directly or
indirectly, take any of the following actions (except to the extent any such
action is specifically authorized under this Agreement, the Securities Purchase
Agreements, the Registration Rights Agreement or an annual business plan
previously approved by the GECC Designee and the THLi Fund Designee in
accordance with this Section):

               (a) merge with or into or consolidate with any other Person;

               (b) voluntarily liquidate, dissolve or wind up or file any
voluntary petition in bankruptcy or for receivership or make any assignment for
the benefit of creditors;

               (c) in any transaction or series of transactions, acquire
(including pursuant to a merger or consolidation) all or any substantial portion
of the business or assets of any Person;

               (d) enter or commit to enter into any joint venture or
partnership or establish any non-wholly-owned subsidiaries or otherwise make any
debt or equity investment in any Person (other than extensions of credit in the
ordinary course of business);

                                        11

<PAGE>   15

               (e) expand into new lines of business (it being understood that
"new lines of business" do not include (i) geographic expansion of the retail
operations conducted by the Company and its Subsidiaries as of the date of this
Agreement and (ii) E-Commerce Activities);

               (f) assign to any other Person any rights of the Company under
this Agreement, the Registration Rights Agreement or the Securities Purchase
Agreements;

               (g) in any transaction or series of transactions, sell, lease or
exchange any assets of the Company and/or any Subsidiary, except for (i) sales
of inventory in the ordinary course of business, (ii) subleasing of vacant
retail space on arm's-length terms and (iii) entering into or terminating leases
in the ordinary course of business pursuant to a procedure adopted by the Board
of Directors and approved by the GECC Designee and the THLi Fund Designee;

               (h) adopt or change any material accounting policy of the Company
or any of its Subsidiaries, except as required by generally accepted accounting
principles;

               (i) create, incur, assume or suffer to exist any Indebtedness
other than (a) Indebtedness in existence as of the date of this Agreement and
interest thereon, reduced to the extent such amounts are repaid or retired, and
any refinancing of such Indebtedness, (b) Indebtedness under the Loan and
Security Agreement dated as of January 20, 1995 between the Company and Congress
Financial Corporation (Western), as amended to the date of this Agreement,
including premium (if any), and interest thereon, (c) Indebtedness already
approved in accordance with this subsection, reduced to the extent such amounts
are repaid, refinanced or retired, and (d) other Indebtedness not to exceed in
the aggregate $200,000 at any time outstanding;

               (j) mortgage, encumber, create, incur or suffer to exist, liens
on its assets (other than liens on assets under Indebtedness outstanding as of
the date hereof and materialmen's, mechanics' and other similar liens arising
for work performed in the ordinary course of business which are not overdue for
more than 30 days);

                                        12

<PAGE>   16

               (k) pay, declare or set aside any sums for the payment of, any
dividends, or make any distribution on, any shares of its capital stock or
redeem, repurchase or otherwise acquire any outstanding shares of its capital
stock or any other of its outstanding securities or Indebtedness (except for
Indebtedness (other than indebtedness to any Related Party, excluding
indebtedness for expenses incurred in the ordinary course of business on behalf
of the Company and its Subsidiaries) to the extent it becomes due in accordance
with its terms);

               (l) make or commit to make (with respect to the Company and all
of its Subsidiaries taken together) during (i) the calendar year ended December
31, 2000, any capital expenditure or capital expenditures in an amount in excess
of $8,000,000 with respect to the Company's retail business and $100,000 with
respect to the Company's E-commerce business and (ii) any other calendar year
any capital expenditure or capital expenditures in an amount in excess of
$100,000;

               (m) issue or sell any shares of capital stock or rights, options,
warrants or other securities exercisable for, exchangeable for or convertible
into shares of capital stock of the Company or any of the Company's
Subsidiaries, other than upon the exercise of options or warrants outstanding on
the date of this Agreement or previously approved in accordance with this
Section, or grant, amend or terminate any stock appreciation right or other
stock-based award;

               (n) enter into, adopt, amend or terminate any employment or
consulting agreement, or hire or retain any person who will report directly to
the Chief Executive Officer or to whom the Company shall pay total compensation
(including, without limitation, compensation in the form of benefits) in excess
of $150,000 per year, or enter into, adopt, amend or terminate any employee
benefit plan, policy or arrangement, except as required by law or generally
accepted accounting principles; provided that the renewal by the Company in the
ordinary course of its business of benefit plans applicable to employees of the
Company, generally, shall not require consent pursuant to this subparagraph (n);

               (o) amend its Certificate or By-laws, including, without
limitation, any change in the number of directors comprising its Board of
Directors, or adopt, amend, redeem or terminate any shareholder rights plan or
similar plan or arrangement;

                                        13

<PAGE>   17

               (p) amend, modify or waive an provision of this Agreement, the
Securities Purchase Agreements, the Registration Rights Agreement or the
agreements ancillary thereto, or become a party to any agreement which by its
terms restricts the Company's or any of its Subsidiaries', or any Stockholder's,
performance of the terms of any of such agreements;

               (q) change its independent certified accountants or actuaries;

               (r) register any securities under the Securities Act or grant any
registration rights therefor;

               (s) enter into, amend or terminate, or waive any material rights
of the Company and its Subsidiaries under, any contract, arrangement or
transaction involving consideration in excess of $100,000 or which is otherwise
material to the Company or any of its Subsidiaries;

               (t) 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
arrangements entered into in the ordinary course of business in compliance with
this Agreement;

               (u) enter into, adopt, amend (whether by agreement or by conduct
of the business), except as required by law or generally accepted accounting
principles, or terminate any annual business plan;

               (v) take any action required by law to be approved by the Board;
or

               (w) agree or otherwise commit to take any of the actions set
forth in the foregoing subparagraphs (a) through (v).

        2.3    MANAGEMENT.

               (a) Chief Executive Officer. Subject to the provisions of this
Agreement and the Employment Agreement, Hawley shall be the Chief Executive
Officer of the Company. In the event of the death, resignation, removal or other
termination of Hawley's services as Chief Executive Officer, any successor Chief
Executive Officer (and any successor(s) thereto) shall be selected by a majority
of

                                        14

<PAGE>   18

the Board; provided that no such person shall be selected without the unanimous
approval of the GECC Designee and the THLi Fund Designee.

               (b) Appointment of Management. Subject to Section 2.2 hereof, all
members of management of the Company (other than the Chief Executive Officer)
shall be designated by, their compensation shall be determined by, and they may
be removed, promoted or demoted by, the Chief Executive Officer of the Company;
provided, however, that the designation of, setting of compensation for, or
removal, promotion or demotion of, any person who will report directly to the
Chief Executive Officer or earn total compensation (including benefits) from the
Company and its Subsidiaries of $150,000 or more per year shall be subject to
the prior approval of the Board.

        2.4 DIRECTORS' INDEMNIFICATION.

               (a) The Company shall obtain and cause to be maintained in
effect, with financially sound insurers, a policy of directors' and officers'
liability insurance covering the Designees (and their respective successors) in
an amount of at least $15,000,000 or such other amount the Board shall specify
(as such amount shall be increased from time to time at the request of GECC or
THLi).

               (b) The Certificate, By-laws and other organizational documents
of the Company and each of its Subsidiaries shall at all times, to the fullest
extent permitted by law, provide for indemnification of, advancement of expenses
to, and limitation of the personal liability of, the members of the Board and
the members of the boards of directors or other similar managing bodies of each
of the Company's Subsidiaries and such other persons, if any, who, pursuant to a
provision of such Certificates, By-laws or other organizational documents,
exercise or perform any of the powers or duties otherwise conferred or imposed
upon members of the Board or the boards of directors or other similar managing
bodies of each of the Company's Subsidiaries. Such provisions may not be
amended, repealed or otherwise modified in any manner adverse to any member of
the Board or any member of the boards of directors or other similar managing
bodies of any of the Company's Subsidiaries, until at least six years following
the termination of this Agreement.

               (c) Each of the Designees is intended to be a third-party
beneficiary of the obligations of the Company pursuant to this Section 2.4, and
the obligations of the Company pursuant to this Section 2.4 shall be enforceable
by the Designees.

                                        15

<PAGE>   19

        2.5 EXPENSES. The Company shall pay the reasonable out-of-pocket
expenses incurred by each of the GECC designee, the Permal Designee, the THLi
Designees, the GECC/THLi Designees and the Joint Designees in connection with
performing his or her duties, including without limitation the reasonable
out-of-pocket expenses incurred by such person attending meetings of the Board
or any committee thereof or meetings of any board of directors or other similar
managing body (and any committee thereof) of any subsidiary of the Company.

        2.6 COOPERATION. Each Stockholder (other than the Hawley Trusts) shall
vote all of its voting shares and shall take all other necessary or desirable
actions within its control (including, without limitation, attending all
meetings in person or by proxy for purposes of obtaining a quorum, executing all
written consents in lieu of meetings and voting to remove members of the Board
or to amend the Certificate, as applicable), and the Company shall take all
necessary and desirable actions within its control (including, without
limitation, calling special Board and stockholder meetings and voting to remove
members of the Board or to amend the Certificate, as applicable), to (a)
effectuate the provisions of Section 2.1 and (b) cause the Company to have a
sufficient number of authorized and unissued shares of Company Stock reserved
for issuance solely for the purpose of effecting conversion of outstanding
Series A Preferred Stock.

        SECTION 3. RESTRICTIONS ON TRANSFERS OF STOCK.

               (a) Notwithstanding anything to the contrary contained herein, no
Stockholder shall Transfer any Stock, except for Sales in bona fide transactions
for value complying with the provisions of this Section 3 and Permitted
Transfers. The Company shall not reflect on its books any Sale of Stock, unless
(a) the Sale is pursuant to an effective registration statement under the
Securities Act and under any applicable state securities or blue sky laws, or
(b) the Selling Stockholder shall have furnished the Company with evidence
reasonably satisfactory to the Company that no such registration is required
because of the availability of an exemption from registration under the
Securities Act and under applicable state securities or blue sky laws. A written
opinion of counsel of recognized standing to the effect set forth in clause (b)
of the preceding sentence shall satisfy the requirements of such clause.

               (b) Any Transfer or attempted Transfer of Stock in violation of
any provision of this Agreement shall be void, and the Company shall not record
such Transfer on its books or treat any purported transferee of such Stock as
the owner of such Stock for any purpose.

                                        16

<PAGE>   20

        SECTION 4. RIGHTS OF FIRST OFFER.

               (a) If any Stockholder (other than the Hawley Trusts) intends to
Sell any Stock (other than (1) Sales pursuant to a registered public offering or
(2) Sales on a national securities exchange which, when aggregated with all
other Sales under this clause (2) by such Stockholder or, if such Stockholder is
a member of a Stockholder Group, all other Sales under this clause (2) by the
members of such Stockholder Group from and after the date of this Agreement,
would represent, in the aggregate, not more than 1,000,000 shares of Common
Stock on a Fully Diluted Basis, as adjusted for stock splits, combinations or
similar transactions):

               (i) The Stockholder intending to transfer such Stock (the
        "Proposing Seller") shall give each other Stockholder (each an
        "Offeree") written notice of its intent to Sell such Stock, specifying
        the number of securities to be sold and the minimum price and terms and
        conditions of such sale and offering to Sell to such Offeree, at such
        minimum price and on such terms and conditions, its pro rata share of
        such Stock (based on the number of shares of Common Stock beneficially
        owned by each Offeree on a Fully Diluted basis); provided that any
        Offeree may, by written notice to the Proposing Seller, elect to
        purchase, in addition to its pro rata share of such Stock, all or any
        portion of the Stock (if any) with respect to which any other Offeree
        fails to exercise its right of first offer under this Section 4, and
        such additional Stock shall be pro-rated among such Offerees in the
        manner described above to the extent such additional Stock is
        oversubscribed;

               (ii) if any Offeree shall not, within 15 days after receipt of
        the notice given pursuant to clause (i) above, accept such offer in
        writing with respect to the Stock specified in such notice, then the
        Proposing Seller shall be free to Sell the Stock specified in the notice
        to such Offeree (but only those securities covered by the notice of
        intention to Sell which no other Offeree shall have agreed to purchase)
        at a price equal to or above the minimum price and on other terms and
        conditions no less favorable to the Proposing Seller than those
        specified in such notice, at any time within 90 days of the expiration
        of such 15-day period;

               (iii) if the Proposing Seller shall not have consummated the
        proposed Sale within 90 days after the expiration of the 15-day period
        referred to in

                                        17

<PAGE>   21

        clause (ii) above, then the Proposing Seller may not thereafter Sell
        such Stock without complying with the provisions of this Section 4; and

               (iv) if any Offeree shall accept such offer within 15 days after
        the notice given pursuant to clause (i) above, then such Offeree shall
        purchase the Stock specified in such notice as promptly as is reasonably
        practicable, but in any event within 45 days after the notice given
        pursuant to clause (i) above or such later date as the Proposing Seller
        may designate within the 90-day period referred to in clause (iii)
        above.

               (b) THLi, GECC and each of the members of the Hawley Group, each
in favor of the others, covenants that if any of them (for purposes of this
Section, a "Permal Offeree") has the opportunity to purchase any Common Stock
("Offered Shares") owned by any member of the Permal Group, whether by offer to
the Permal Offeree from a member of the Permal Group or due to a solicitation by
the Permal Offeree, or otherwise, the Permal Offeree shall promptly notify the
parties subject to (and entitled to the benefits of) this Section 4(b)(v) of the
opportunity and shall allow them the right to participate in such purchase and
acquire Offered Shares. The number of Offered Shares that may be purchased by
each of them, respectively, shall be (i) as among GECC, THLi and all of the
members of the Hawley Group together, in proportion to the number of shares of
Common Stock owned by GECC, THLI or the Hawley Group, respectively, as a
percentage of the aggregate number of shares of Common Stock then owned by GECC,
THLi and all members of the Hawley Group together, and (ii) as among the members
of the Hawley Group, in proportion to the number of shares of Common Stock owned
by such member as a percentage of the number of shares of Common Stock then
owned by all Hawley Group members electing to purchase Common Stock hereunder.
The rights in this Section 4(b) are in addition to and subordinate to the other
provisions of this Stockholders Agreement. Any failure to exercise the rights
in the Section within 15 days of receipt of notice shall be deemed a waiver of
such rights.

        SECTION 4A. HAWLEY TRUST STOCK RIGHTS OF FIRST OFFER. If any of the
Hawley Trusts intends to sell any Stock (other than (1) Sales pursuant to a
registered public offering or (2) Sales on a national securities exchange which,
when aggregated with all other Sales under this clause (2) by the Hawley Group
from and after the date of this Agreement, would represent, in the aggregate,
not more than 1,000,000 shares of Common Stock on a Fully Diluted Basis, as
adjusted for stock splits, combinations or similar transactions):

                                        18

<PAGE>   22

               (i) the Hawley Trust intending to transfer such Stock (the
        "Hawley Trust Seller") shall give the Company, GECC, THLi and the Permal
        Group written notice (the "Hawley Trust Seller Notice") of its intent to
        Sell such Stock, specifying the number of securities to be sold and the
        minimum price and terms and conditions of such sale, and offering to
        Sell to the Company, GECC, THLi and the Permal Group, at such minimum
        price and on such terms and conditions. The Company shall provide a copy
        of any Hawley Trust Seller Notice to each Stockholder within two days
        after receipt by it of the Hawley Trust Seller Notice. The Company shall
        have the right to purchase all or any part of such Stock by giving
        written notice to the Hawley Trust Seller, GECC, THLi and the Permal
        Group within two days after receipt by it of the Hawley Trust Seller
        Notice, specifying the number of shares of such Stock to be so purchased
        by the Company. If the Company elects to purchase none of, or less than
        all, the Stock that is the subject of the proposed Transfer by the
        Hawley Trust Seller, then GECC, THLi and the Permal Group shall have the
        right to purchase their pro rata share of any or all of the available
        Stock (and, if either elects not to purchase its full pro rata share,
        the Stock not so purchased) by giving written notice to the Hawley Trust
        Seller and the Company within seven days after receipt by it of the
        Hawley Trust Seller Notice (the "Notice Period"); provided that any
        other Stockholder (each, an "Electing Stockholder") may, by written
        notice to GECC, THLi and the Permal Group prior to the expiration of the
        Notice Period elect to purchase its pro rata share of the available
        Stock, and any such Electing Stockholder may elect to purchase, in
        addition to its pro rata share of the available Stock, all or any
        portion of the Stock (if any) with respect to which GECC, THLi, the
        Permal Group or any other Stockholder fails to exercise its right under
        this Section 4A, and such additional Stock shall be pro-rated among such
        Electing Stockholders in the manner described above to the extent such
        additional Stock is oversubscribed;

               (ii) GECC shall act as agent for the Electing Stockholders in
        connection with any exercise by an Electing Stockholder of its rights
        under this Section and the Hawley Trust Seller shall not be obligated to
        deal with any Stockholder other than GECC in connection with any
        purchase and sale under this Section 4A; provided that GECC shall have
        no liability to the Hawley Trust Seller if GECC fails to purchase any
        Stock which GECC disclosed in writing to the Hawley Trust Seller at the
        time of delivery of GECC's election to purchase was being purchased by
        GECC solely as agent for one or more

                                        19

<PAGE>   23

        Electing Stockholders; and GECC shall have no liability to any other
        Stockholder for any act or omission by GECC under this Section 4A;

               (iii) if the Company, GECC, THLi and the Permal Group fail to
        elect to purchase all the Stock specified in the Hawley Trust Seller
        Notice, then the Hawley Trust Seller shall be free to sell, pursuant to
        a Shelf Registration Statement, the portion of such Stock as to which no
        election to purchase has been made by the Company, GECC, THLi or the
        Permal Group at a price equal to or above the minimum price and on other
        terms and conditions no less favorable to the Hawley Trust Seller than
        those specified in the Hawley Trust Seller Notice, at any time within 90
        days of the expiration of the seven-day period referred to in clause (i)
        above;

               (iv) if the Hawley Trust Seller shall not have consummated the
        proposed Transfer within 90 days after the expiration of the seven-day
        period referred to in clause (ii) above, then the Hawley Trust Seller
        may not thereafter Transfer such Stock without complying with the
        provisions of this Section 4A;

               (v) any Electing Stockholder shall provide to GECC all funds
        required, and shall execute and deliver to GECC all documents reasonably
        requested by GECC, in connection with the purchase by GECC of any Stock
        as agent for such Electing Stockholder, and GECC shall deliver
        certificates representing the Stock acquire by such Electing Stockholder
        to such Stockholder promptly following the consummation of any purchase
        under this Section 4A and the satisfaction by such Electing Stockholder
        of his obligations under this clause (v).

        SECTION 5. TAG-ALONG RIGHTS.

               (a) If GECC, any member of Permal Group, or THLi whether acting
alone or in concert with any other Stockholder (collectively, the "Selling
Stockholders") pursuant to a common plan, understanding or arrangement, shall
enter into an agreement to Sell or otherwise propose to Sell to any Person or
Group (other than pursuant to a registered public offering) (such Person or
Group, the "Tag-along Transferee"), in one transaction or a series of related
transactions, any Stock, such that immediately following the consummation of
such Sale, the Selling Stockholders would have Sold to such Person or Group in
the aggregate Stock representing in excess of 3,000,000 shares of Common Stock
on a Fully Diluted Basis, as adjusted

                                        20

<PAGE>   24

for stock splits, combinations or similar transactions (a "Tag-along Sale")
(such number of shares of Stock being referred to herein as the "Tag-along
Number"), then each of the other Stockholders (each a "Tag-along Offeree") shall
have the right to participate in such Tag-Along Sale by selling a number of
shares of Common Stock equal to such Stockholder's Proportionate Share, as part
of the Tag-Along Sale by the Selling Stockholders, on the same terms as those
applicable to the Tag-Along Sale (except that, if the Tag-Along Sale involves
Common Stock Equivalents, the economic terms of such Sale shall be appropriately
adjusted to reflect that the Tag-Along Offerees are selling Common Stock).

               (b) The Selling Stockholders shall provide to each Tag-Along
Offeree written notice of any Tag-Along Sale (the "Tag-along Notice"), not more
than 45 and not less than 15 days prior to the Tag-Along Sale, setting forth the
terms of the Tag-Along Sale and specifically identifying the Tag-Along
Transferee of the Stock, and shall give each Tag-Along Offeree at least 10 days
after delivery of the Tag-Along Notice within which to exercise its rights
contained in this Section 5, by written notice thereof to the Selling
Stockholder.

        SECTION 6. CONFLICTING AGREEMENTS. Each Stockholder represents and
warrants that such Stockholder has not granted and is not a party to any proxy,
voting trust or other agreement which is inconsistent with or conflicts with any
provision of this Agreement, and no holder of Stock shall grant any proxy or
become party to any voting trust or other agreement which is inconsistent with
or conflicts with any provision of this Agreement.

        SECTION 7. LEGEND. (a) Each Stockholder and the Company shall take all
such action necessary (including exchanging with the Company certificates
representing shares of Stock issued prior to the date hereof) to cause each
certificate representing outstanding shares of Stock (other than shares which
have been registered under the Securities Act, to which the first paragraph of
such legends shall not apply) to 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."

                                        21

<PAGE>   25

        "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 BETWEEN THE COMPANY
AND GENERAL ELECTRIC CAPITAL CORPORATION AND 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."

        The first paragraph of the legends shall be removed from certificates
for shares transferred pursuant to Rule 144 under the Securities Act or when
such shares are transferred in any other transaction, in each case if the seller
delivers to the Company an opinion of its counsel, which counsel and opinion
shall be reasonably satisfactory to the Company, or a "no-action" letter from
the staff of the Securities and Exchange Commission, in either case to the
effect that such legend is no longer necessary in order to protect the Company
against a violation by it of the Securities Act upon any Sale or other
disposition of such shares without registration thereunder. The requirement that
the above legend regarding this Agreement be placed upon certificates evidencing
shares of Stock shall cease and terminate upon the Sale of such shares, other
than pursuant to a Permitted Transfer. Upon the consummation of any event
requiring the removal of a legend hereunder, the Company, upon the surrender of
certificates containing such legend, shall, at its own expense, deliver to the
holder of any such shares as to which the requirement for such legend shall have
terminated, one or more new certificates evidencing such shares not bearing such
legend.

               (b) Any provision herein to the contrary notwithstanding,
certificates for up to 1,000,000 shares of Common Stock held by the Hawley
Trusts shall not be required to bear legends required by this Agreement so long
as such shares may sold under Rule 144(k) under the Securities Act or are not
"restricted securities" within the meaning of Rule 144 under the Securities Act.

                                        22

<PAGE>   26

        SECTION 8. REPRESENTATIONS AND WARRANTIES.

               (a) Each party hereto represents and warrants to the other
parties hereto as follows:

               (i) it has full power and authority to execute, deliver and
        perform its obligations under this Agreement;

               (ii) this agreement has been duly and validly authorized,
        executed and delivered by it, and constitutes a valid and binding
        obligation of it, enforceable against it in accordance with its terms
        except to the extent that enforceability may be limited by bankruptcy,
        insolvency or other similar laws affecting creditors' rights generally;

               (iii) the execution, delivery and performance of this Agreement
        by it does not (x) violate, conflict with, or constitute a breach of or
        default under its organizational documents, if any, or any agreement to
        which it is a party or by which it is bound or (y) violate any law,
        regulation, order, writ, judgment, injunction or decree applicable to
        it;

               (iv) no consent or approval of, or filing with, any governmental
        or regulatory body is required to be obtained or made by it in
        connection with the transactions contemplated hereby; and

               (v) it is not a party to any agreement which is inconsistent with
        the rights of any party hereunder or otherwise conflicts with the
        provisions hereof.

               (b) each Signatory Stockholder severally represents and warrants
to GECC and THLi with respect only to GECC and THLi and not any other
Stockholder as follows:

               (i) Schedule B hereto sets forth a list of all securities of the
        Company (including, without limitation, shares of capital stock,
        convertible securities, debentures, etc.) held of record or beneficially
        owned by it immediately after the date hereof; and

                                        23

<PAGE>   27

               (ii) except as set forth on Schedule B hereto and other than this
        Agreement and the Registration Rights Agreement, it is not a party to
        any contract or agreement, written or oral, with respect to the voting
        or transfer of securities of the Company (including, without limitation,
        any voting agreement, voting trust, stockholder's agreement,
        registration rights agreement, etc.).

        SECTION 9. DURATION OF AGREEMENT. Subject to the last sentence of this
Section, the rights and obligations of a Stockholder under this Agreement shall
terminate at such time as such Stockholder no longer is the beneficial owner of
any shares of Stock. As to any of GECC's rights or obligations under this
Agreement, this Agreement shall terminate at such time as GECC no longer is the
beneficial owner of 2,000,000 or more of the outstanding shares of Common Stock
on a Fully Diluted Basis, subject to adjustment for stock splits, combinations
or similar transactions, or at such earlier time as may be agreed by GECC,
Permal Group and THLi (or, if applicable, THLi's transferee pursuant to Section
14(ii)).

        As to any of THLi's rights or obligations under this Agreement, this
Agreement shall terminate at such time as THLi (and any transferee's assigned
rights under this Agreement pursuant to Section 14) no longer beneficially owns
2,000,000 or more of the outstanding shares of Common Stock on a Fully Diluted
Basis, subject to adjustment for stock splits, combinations or similar
transactions, or at such earlier time as may be agreed by GECC, Permal Group and
THLi (or such transferee, if applicable).

        This Agreement (other than Section 4A), shall terminate as to any member
of the Hawley Group six months after Hawley ceases to be a Director of the
Company.

               Any provision herein to the contrary notwithstanding, the
provisions of Sections 3, 4, 4A, 5 and 7 of this Agreement shall not be
applicable to any shares of Stock first acquired by any member of the Hawley
Group after August 26, 1996 or by any member of the Permal Group, GECC or THLi
after the date hereof.

        SECTION 10. FURTHER ASSURANCES. At any time or from time to time after
the date hereof, the parties agree to cooperate with each other, and at the
request of any other party, to execute and deliver any further instruments or
documents and to take all such further action as the other party may reasonably
request in order to evidence or effectuate the consummation of the transactions
contemplated hereby and to otherwise carry out the intent of the parties
hereunder.

                                        24

<PAGE>   28
        SECTION 11. AMENDMENT AND WAIVER. Except as otherwise provided herein,
no modification, amendment or waiver of any provision of this Agreement shall be
effective against the Company or any Stockholder unless such modification,
amendment or waiver is approved in writing by the Company, Stockholders holding
at least a majority of the Common Stock, and, so long as it holds any shares of
Stock, by GECC or THLi. The failure of any party to enforce any of the
provisions of this Agreement shall in no way be construed as a waiver of such
provisions and shall not affect the right of such party thereafter to enforce
each and every provision of this Agreement in accordance with its terms.

        SECTION 12. SEVERABILITY. Whenever possible, each provision of this
Agreement shall be interpreted in such manner as to be effective and valid
under applicable law, but if any provision of this Agreement is held to be
invalid, illegal or unenforceable in any respect under any applicable law or
rule in any jurisdiction, such invalidity, illegality or unenforceability shall
not affect any other provision or any other jurisdiction, but this Agreement
shall be reformed, construed and enforced in such jurisdiction as if such
invalid, illegal or unenforceable provision had never been contained herein.

        SECTION 13. ENTIRE AGREEMENT. Except as otherwise expressly set forth
herein, this document and the other documents dated the date hereof executed in
connection herewith embody the complete agreement and understanding among the
parties hereto with respect to the subject matter hereof and supersedes and
preempts any prior understandings, agreements or representations by or among the
parties, written or oral, which may have related to the subject matter hereof in
any way.

        SECTION 14. SUCCESSORS AND ASSIGNS. Except as otherwise provided herein,
this Agreement shall bind and inure to the benefit of and be enforceable by the
Company and its successors and assigns and each Stockholder and their respective
successors, assigns, heirs and personal representatives, so long as they hold
Stock. No Stockholder shall have the right to assign its rights and obligations
under this Agreement, except pursuant to (i) a Permitted Transfer or (ii) a
transfer by THLi of more than 50% of the Stock (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) held by THLi as of the date of this Agreement (in
which case the transferee shall be entitled to exercise all rights, and shall be
bound by all obligations, of its transferor under this Agreement).

                                        25

<PAGE>   29

        SECTION 15. COUNTERPARTS. This Agreement may be executed in separate
counterparts each of which shall be an original and all of which taken together
shall constitute one and the same agreement.

        SECTION 16. REMEDIES. Each Stockholder shall be entitled to enforce its
rights under this Agreement specifically to recover damages by reason of any
breach of any provision of this Agreement and to exercise all other rights
existing in their favor. The parties hereto agree and acknowledge that money
damages may not be an adequate remedy for any breach of the provisions of this
Agreement and that each party may in its sole discretion apply to any court of
law or equity of competent jurisdiction for specific performance and/or
injunctive relief (without posting a bond or other security) in order to enforce
or prevent any violation of the provisions of this Agreement.

        SECTION 17. 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 and to each Stockholder as set forth below and to any
subsequent holder of Stock subject to this Agreement at such address as
indicated by the Company's records, or at such address or to the attention of
such other person as the recipient party has specified by written notice to the
sending party:

                                  The Company:

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

                                 with copies to:

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

                                        26

<PAGE>   30

                                       and

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

                              To each Stockholder:

            At the address for such Stockholder set forth on Schedule
                               B attached hereto.

                                 with a copy to:

                    Fried, Frank, Harris, Shriver & Jacobson
                               One New York Plaza
                            New York, New York 10004
                           Facsimile #: (212) 859-4000
                         Attention: Warren de Wied, Esq.

                                       and

                          Stroock & Stroock & Lavan LLP
                                7 Hanover Square
                            New York, New York 10004
                           Facsimile #: (212) 806-6006
                         Attention: David Kaufman, Esq.

                                       and

                    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.

                                        27

<PAGE>   31

        SECTION 18. 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. 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.

        SECTION 19. DESCRIPTIVE HEADINGS. The descriptive headings of this
Agreement are inserted for convenience only and do not constitute a part of this
Agreement.

        SECTION 20. CONSTRUCTION. Where specific language is used to clarify by
example a general statement contained herein, such specific language shall not
be deemed to modify, limit or restrict in any manner the construction of the
general statement to which it relates. The language used in this Agreement shall
be deemed to be the language chosen by the parties hereto to express their
mutual intent, and no rule of strict construction shall be applied against any
party.

                                        28

<PAGE>   32

        IN WITNESS WHEREOF, the parties hereto have executed this Stockholders
Agreement on the day and year first above written.

                                        KRAUSE'S FURNITURE, INC.

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

<PAGE>   33

                                        GE CAPITAL EQUITY INVESTMENTS, INC.

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

                                        GENERAL ELECTRIC CAPITAL CORPORATION

                                        By:____________________________________
                                           Name: George L. Hashbarger, Jr.
                                           Title: Department Operations Manager

<PAGE>   34

                                             PERMAL CAPITAL MANAGEMENT, INC.

                                             By:________________________________
                                                Name:
                                                Title:

                                             PERMAL SERVICES, INC.

                                             By:________________________________
                                                Name:
                                                Title:

                                             PERMAL CAPITAL PARTNERS, L.P.

                                             By: PERMAL MANAGEMENT CORPORATION,
                                                 its Investment Manager

                                             By:________________________________
                                                Name:
                                                Title:

                                             PERMAL ASSET MANAGEMENT

                                             By:________________________________
                                                Name:
                                                Title:

                                             PERMAL SPECIAL OPPORTUNITIES, LTD.

                                             By:________________________________
                                                Name:

<PAGE>   35

                                               Title:
                                             JAPAN OMNIBUS LTD.

                                             By:________________________________
                                                Name:
                                                Title:

                                             JEAN R. PERRETTE

                                             By:________________________________

                                             ISAAC ROBERT SOUEDE

                                             By:________________________________

                                             THOMAS M. DELITTO

                                             By:________________________________

                                             THOMAS M. AND DONNA S. DELITTO

                                             By:________________________________
                                                Name: Thomas M. DeLitto

                                             By:________________________________
                                                Name: Donna S. DeLitto

                                             UNITED GULF BANK (B.S.C.) E.C.

<PAGE>   36

                                             By:________________________________
                                                Name:
                                                Title:

                                             KUWAIT INVESTMENT PROJECTS COMPANY

                                             By:________________________________
                                                Name:
                                                Title:

                                             ATCO HOLDINGS, LTD.

                                             By:________________________________
                                                Name:
                                                Title:

                                             ATCO DEVELOPMENT, INC.

                                             By:________________________________
                                                Name:
                                                Title:

<PAGE>   37

                                             PILOT HOLDINGS, L.P.

                                             By: SHED INVESTMENTS, LLC,
                                             its General Partner

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

<PAGE>   38

                                             ALLISON BOOTH HAWLEY TRUST I

                                             By:________________________________
                                                Name:
                                                Title:

                                             CAITLIN HALE HAWLEY TRUST I

                                             By:________________________________
                                                Name:
                                                Title:

                                             MAUREEN ERIN HAWLEY TRUST I

                                             By:________________________________
                                                Name:
                                                Title:

                                             SHANNON FOLLEN HAWLEY TRUST I

                                             By:________________________________
                                                Name:
                                                Title:

                                             HAWLEY FAMILY TRUST

                                             By:________________________________
                                                Name:
                                                Title:

<PAGE>   39

                                             DR. PHILIP M. HAWLEY, JR.

                                             By:________________________________

                                             PHILIP M. HAWLEY

                                             By:________________________________

<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

                                        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

<PAGE>   41

                                             ASCEND PARTNERS, L.P.

                                             By:________________________________
                                                Name:
                                                Title:

                                             LARRY BLACK

                                             By:________________________________

                                             BRANAGH REVOCABLE TRUST

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

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

                                             MATTHEW WILLIAM CLARKE - IRA

                                             By:________________________________
                                                Name:
                                                Title:

                                             SANFORD J. COLEN

                                             By:________________________________

<PAGE>   42

                                             AARON J. COLEN, UTMA, CA

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

                                             ELYSE L. COLEN, UTMA, CA

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

                                             SARA K. COX

                                             By:________________________________

                                             JOHN DAVIES

                                             By:________________________________

                                             DIAMOND A. PARTNERS, L.P.

                                             By:________________________________
                                                Name:
                                                Title:

                                             J. STEVEN EMERSON

<PAGE>   43

                                             By:________________________________

                                             EMILY FAIRBAIRN - IRA

                                             By:________________________________
                                                Name:
                                                Title:

                                             MALCOLM FAIRBAIRN - IRA

                                             By:________________________________
                                                Name:
                                                Title:

                                             WILLIAM T. AND KATHLEEN P. GIBSON

                                             By:________________________________
                                                Name: William T. Gibson

                                             By:________________________________
                                                Name: Kathleen P. Gibson

                                             JONATHAN & NANCY GLASER
                                             FAMILY TRUST

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

                                             By:________________________________
                                                Name: Nancy Ellen Glaser

<PAGE>   44

                                                  Title:    Trustee

                                             EDWARD M. HAWLEY

                                             By:________________________________

                                             GEORGE P. HAWLEY

                                             By:________________________________

                                             VICTOR F. HAWLEY

                                             By:________________________________

                                             RICHARD HICKS

                                             By:________________________________

                                             KATHRYN JERGENS TRUST

                                             By:________________________________
                                                Name:
                                                Title:

                                             DIANE JOHNSON

<PAGE>   45

                                             By:________________________________

                                             RICHARD M. KELLER

                                             By:________________________________

                                             STEPHEN M. KELLER

                                             By:________________________________

                                             STEPHEN F. KELLER PROFESSIONAL
                                              CORPORATION DEFINED BENEFIT
                                              PLAN

                                             By:________________________________
                                                Name:
                                                Title:

                                             PAUL KESSLER

                                             By:________________________________

                                             SIDNEY KIMMEL

                                             By:________________________________

                                             THEODORE D. KONOPISOS

<PAGE>   46

                                             By:________________________________

                                             PETER LAMM

                                             By:________________________________

                                             ROBERT LONDON

                                             By:________________________________

                                             JEFFREY S. MORGAN

                                             By:________________________________

                                             THE MUHL FAMILY TRUST

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

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

                                             PACIFIC SECURITY GROUP, INC.

                                             By:________________________________

<PAGE>   47

                                             By:________________________________
                                                Name:
                                                Title:

                                             POINTE INVESTMENTS CAPITAL, LTD.

                                             By:________________________________
                                                Name:
                                                Title:

                                             POLLAT, EVANS & CO., INC.

                                             By:________________________________
                                                Name:
                                                Title:

                                             KEVIN AND ERIN PRZYBOCKI

                                             By:________________________________
                                                Name: Kevin Przybocki

                                             By:________________________________
                                                Name: Erin Przybocki

                                             CHARLES B. RUNNELS, JR.

                                             By:________________________________

                                             CHARLES B. RUNNELS, III

                                             By:________________________________

<PAGE>   48

                                             G. TYLER RUNNELS.

                                             By:________________________________

                                             LORD ROBIN RUSSELL

                                             By:________________________________

                                             TIMOTHY MICHAEL WALLACE

                                             By:________________________________

                                             WAVE ENTERPRISES, INC.

                                             By:________________________________
                                                Name:
                                                Title:

                                             IRA WEINGARTEN

                                             By:________________________________

                                             J.D. YATES

                                             By:________________________________

<PAGE>   49

                                             ZAXIS PARTNERS, L.P.

                                             By:________________________________
                                                Name:
                                                Title:

<PAGE>   50

                                   SCHEDULE A

                            HAWLEY GROUP CONSISTS OF:

                          Allison Booth Hawley Trust I
                           Caitlin Hale Hawley Trust I
                           Maureen Erin Hawley Trust I
                          Shannon Follen Hawley Trust I
                               Hawley Family Trust
                            Dr. Philip M. Hawley, Jr.
                                Philip M. Hawley

                                      A - 1

<PAGE>   51
                                   SCHEDULE B

                             STOCKHOLDER INFORMATION

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Th Lee.Putnam Internet Partners, L.P.      134,000                   0
   200 Madison Avenue, Suite 2225
   New York, New York 10016
   Facsimile #:  (212) 951-8655
   Attention:  Christine Kim

Th Lee.Putnam Internet Partners, L.P.      126,000                   0
   200 Madison Avenue, Suite 2225
   New York, New York 10016
   Facsimile #:  (212) 951-8655
   Attention:  Christine Kim

GE Capital Equity Investments, Inc.         20,000           7,400,000(1)
   260 Long Ridge Road
   Stamford, Connecticut  06927

ATCO Holdings, Ltd                            0                832,322(2)
   c/o ATCO Development Inc.
   1177 Katy Freeway, Suite 175
   Houston, TX  77079-1772

Isaac Robert Souede                           0                523,798(2)
   30 Dupont Avenue
   White Plains, NY  10605-3536

Jean R. Perrette                              0                655,854(2)
   14 E. 90th Street, #9A
   New York, NY  10128-0671

ATCO Development, Inc.                      5,000              253,167(2)
   1177 Katy Freeway, Suite 175N
   Houston, TX  77079-1772
</TABLE>

                                       1
<PAGE>   52

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Permal Noscal, Ltd.                           0              405,000(2)
   c/o Apex Capital LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, CA  94563-2584

Fairmont Services Ltd.                        0              429,009(2)
   Attn:  John Watts
   P.O. Box N3918
   Nassau
   Bahamas

Ascend Partners, L.P.                       6,500                  0(2)
   One Valley High
   Lafayette, California  94549
   Attention:  Malcolm Fairbairn,
   c/o Emily Wang

Emmanuel Bagdjian                                             75,000(2)
   P.O. Box 644
   1211 Geneva 4
   Switzerland

Bank Insinger De Beaufort                   3,750                  0(2)
   11777 San Vicente Blvd, Suite 702
   Los Angeles, California  90049
   Attention:  Diana Deryez

Larry Black                                 1,000                  0(2)
   c/o Black and Company
   One SW Columbia Street
   Portland, Oregon  97258

Branagh Revocable Trust                      300               6,710(2)
   Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563
   Attention:  Sanford J. Colen
</TABLE>

                                       2
<PAGE>   53

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Carlton Securities NV                                        108,822(2)
  Attn:  John Watts
  P.O. Box N3918
  Nassau
  Bahamas

Matthew William Clarke                      2,000                  0(2)
   314 Edgar Gooch Road
   Hazel Green, AL  35750

Sanford J. Colen                             900              20,000(2)
   Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563
   Attention:  Sanford J. Colen

Aaron J. Colen, UTMA, CA                     250                   0(2)
   Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563
   Attention:  Sanford J. Colen

Elyse L. Colen, UTMA, CA                     250                   0(2)
   Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563
   Attention:  Sanford J. Colen

Sarah K. Cox                                 500                   0(2)
   101 South Las Palmas Avenue
   Los Angeles, CA  90004

John Davies                                 1,250                  0(2)
   c/o Tyler Runnels
   1999 Avenue of the Stars,
   Suite 2530
   Los Angeles, California  90067
</TABLE>

                                       3
<PAGE>   54

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Thomas M. DeLitto                                             25,528(2)
   38 Edinburg Lane
   Trumbull, CT 06611-1065

Diamond A. Partners, L.P.                   2,625                  0(2)
   Lawndale Capital Management,
   L.L.C.
   One Sansome Street, Suite 3900
   San Francisco, California 94104
   Facsimile #: 415-288-2323
   Attention:  Andrew E. Shapiro

J. Steven Emerson, Roth I.R.A.              6,250                  0(2)
   Bear Stearns Custodian
   Emerson Investment Group
   10506 Ilona Avenue, Suite 1410
   Los Angeles, California  90064
   Attention: J. Steven Emerson

Emily Fairbairn - IRA                       4,500                  0(2)
   One Valley High
   Lafayette, California  94549
   Attention:  Emily Wang

Malcolm Fairbairn - IRA                     1,500                  0(2)
   One Valley High
   Lafayette, California  94549
   Attention:  Emily Wang

William T. And Kathleen P. Gibson            500                   0(2)
   109 La Plata
   Santa Barbara, California  93109

Jonathan & Nancy Glaser Family Trust        2,000                  0(2)
   1999 Avenue of the Stars,
   Suite 2530
   Los Angeles, California 90067

Edward M. Hawley                             200                   0(2)
   129 North Van Ness
   Los Angeles, California  90004
</TABLE>

                                       4
<PAGE>   55

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
George P. Hawley                             200                     0(2)
   116 North Citrus Avenue
   Los Angeles, California  90036
   Facsimile #:  (323) 939-9555

Allison Booth Hawley Trust I                2,500              112,500
   238 South Lorrainne
   Los Angeles, California  90004
   Attention:  John F. Hawley

Caitlin Hale Hawley Trust I                 2,500              112,500
   238 South Lorrainne
   Los Angeles, California  90004
   Attention:  John F. Hawley

Hawley Family Trust                         2,500              500,000
   238 South Lorrainne
   Los Angeles, California  90004
   Attention:  John F. Hawley

Maureen Erin Hawley Trust I                 2,500              112,500
   238 South Lorrainne
   Los Angeles, California  90004
   Attention:  John F. Hawley

Shannon Follen Hawley Trust I               2,500              112,500
   238 South Lorrainne
   Los Angeles, California  90004
   Attention:  John F. Hawley

Dr. Philip Hawley, Jr.                      1,250               20,000(2)
   165 South Las Palmas
   Los Angeles, California
   90004-1085

Victor F. Hawley                             200                     0(2)
   122 South Plymouth Boulevard
   Los Angeles, California  90005
   Facsimile #:  (323) 931-2052

Richard Hicks                               6,000                    0(2)
   21 Tanfield Road
   Tiburon, California  94920
</TABLE>

                                       5
<PAGE>   56

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Ian Jack                                    2,000                  0(2)
   630 South Lucerne
   Los Angeles, CA  90005

Kathryn Jergens Trust                        250                   0(2)
   1999 Avenue of the Stars, Suite 2530
   Los Angeles, California  90067
   Facsimile #:  (310) 201-2712
   Attention:  Kathryn Jergens

Diane Johnson                                200                   0(2)
   9901 Manassas Place
   Tucson, Arizona  85748

Richard M. Keller                            500                   0(2)
   101 South Las Palmas Avenue
   Los Angeles, California  90004

Stephen M. Keller                            500                   0(2)
   30 East 81st Street, Apt. 7E
   New York, New York  10028
   Attention:  Elizabeth Hughes

Stephen F. Keller Professional              1,500                  0(2)
   Corporation Defined Benefit Plan
   101 South Las Palmas Avenue
   Los Angeles, California  90004
   Attention:  Stephen F. Keller

Sidney Kimmel                                125              55,130(2)
   Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563
   Attention:  Sanford J. Colen

Konopisos Family Trust Dated 12/15/80       1,250                  0(2)
   17291 Irvine Boulevard, Suite 254
   Tustin, California  92780
   Attention:  Elizabeth Hughes
</TABLE>

                                       6
<PAGE>   57

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Peter Lamm                                  2,000                  0(2)
   1655 El Camino Real
   Palo Alto, California  94306

Robert London                               6,000                  0(2)
   Cruttenden Roth
   809 Presidio Avenue, Suite B
   Santa Barbara, California  93101
   Attention:  Robert London

Jeffrey S. Morgan                            200                   0(2)
   27 Horseshoe Lane
   Rolling Hills Estates, CA  90274
   Facsimile #:  (310) 516-2310
   Attention:  Jeffrey S. Morgan

Jeffrey S. Morgan BSSC Master                425                   0(2)
   Defined Contribution Pension Plan
   Bear Stearns  Corp. Custodian
   One Metrotech Center North
   Brooklyn, New York  11201
   Facsimile #:  (310) 516-2310
   Attention:  Jeffrey S. Morgan

The Muhl Family Trust                        625                   0(2)
   500 South Buena Vista
   Burbank, California  91521-0312
   Attention:  Phillip E. Muhl or
   Kristen A. Muhl

Pacific Security Group, Inc.                 500                   0(2)
   2224 Walsh Tarlton, Suite 200
   Austin, Texas  78746

Permal U. S. Opportunities, Ltd.            1,000                  0(2)
   Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563
   Attention:  Sanford J. Cole
</TABLE>

                                       7
<PAGE>   58

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Pilot Holdings, L.P.                        5,000                  0(2)
   177 Post Road West
   Westport, Connecticut  96880
   Facsimile:  (203) 222-7187
   Attention;  Thomas M. DeLitto

Pointe Investments Capital, Ltd.            2,000                  0(2)
   638 North Faring
   Los Angeles, California  90077
   Attention: Mohamed Hadid

Pollat, Evans & Co., Inc.                    175              17,737(2)
   Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563
   Attention:  Sanford J. Cole

Kevin and Erin Przybocki                     200                   0(2)
   1104 Vancouver Avenue
   Burlingame, California  94010

Quadra Appreciation Fund Inc.                                  5,000(2)
   c/o Apex Capital LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, CA 94563-2584

Charles B. Runnels, Jr.                       625                  0(2)
   2029 Avenue of the Stars,
   Suite 2530
   Los Angeles, California  90067
   Attention:  Tyler Runnels

Charles B. Runnels, III                       625                  0(2)
   10095 East Charter Oak
   Scottsdale, Arizona 85260

G. Tyler Runnels                            5,600                  0(2)
   1999 Avenue of the Stars,
   Suite 2530
   Los Angeles, California  90067
   Facsimile:  (310) 201-2712
</TABLE>

                                       8
<PAGE>   59

<TABLE>
<CAPTION>
                                      SHARES OF SERIES A
                                       CONVERTIBLE PREF.   SHARES OF COMMON
                                       STOCK PURCHASED       STOCK OWNED
                                      ------------------   ----------------
<S>                                   <C>                  <C>
Lord Robin Russell                           250                   0(2)
   Park House
   Woburn Park
   Woburn
   Milton Keynes
   MK17 9PQ England

Timothy Michael Wallace                     2,500                  0(2)
   116 South McCadden Place
   Los Angeles, California  90004
   Attention:  Tyler Runnels

United Gulf Bank (B.S.C.) E.C.                               201,098(2)
   P.O. Box 5964
   Manama Bahrain

Wave Enterprises, Inc.                       250                   0(2)
   24255 Pacific Coast Highway
   Malibu, California  90263-4458
   Attention:  Mike E. O'Neal

Ira Weingarten                               625                   0(2)
   Equity Communications
   1512 Grand Avenue, Suite 200
   Santa Barbara, California  93103
   Attention:  Ira Weingarten

David Weinstein                              400                   0(2)
   5523 Asphon Court
   Boca Raton, Florida  33486
   Facsimile #:  (561) 988-7913

J. D. Yates                                  250                   0(2)
   1235 Lane 30-1/4
   Pueblo, Colorado  81006
</TABLE>

                                       9
<PAGE>   60

Zaxis Partners, L.P.                                         210,000(2)
   c/o Apex Capital, LLC
   Pine Grove
   4 Orinda Way, Suite 240-B
   Orinda, California  94563

(1)  Indicates shares beneficially owned within the meaning of Rule 13D under
     the Securities Exchange Act of 1934.

(2)  Based on Shareholder List prepared by Equiserve Shareholder Services.

                                       10
<PAGE>   61

                                   SCHEDULE C

                            PERMAL GROUP CONSISTS OF:

                         Permal Capital Management, Inc.
                              Permal Services, Inc.
                          Permal Capital Partners, L.P.
                             Permal Asset Management
                       Permal Special Opportunities, Ltd.
                               Japan Omnibus Ltd.
                                Jean R. Perrette
                               Isaac Robert Souede
                                Thomas M. DeLitto
                          Thomas M. & Donna S. DeLitto
                         United Gulf Bank (B.S.C.) E.C.
                           Kuwait Investment Projects
                               ATCO Holdings Ltd.
                             ATCO Development, Inc.

                                       C-1

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