Document:

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                                                                   EXHIBIT 10.16

               AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT

                                  by and among

                            KRAUSE'S FURNITURE, INC.

                                       and

              THE STOCKHOLDERS LISTED ON THE SIGNATURE PAGES HEREOF

                          Dated as of January 14, 2000

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     Amended and Restated Registration Rights Agreement (this "Agreement"),
dated 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 hereto (the "Investors").

     1. Background. The Investors own shares of either the Company's common
stock, par value $.001 per share (the "Common Stock") or the Company's Series A
Convertible Preferred Stock, par value $.0001 per share, (the "Series A
Preferred Stock"), which is convertible into Common Stock. In connection with a
Securities Purchase Agreement between the Company and the purchasers listed
thereto, dated August 26, 1996, the Company entered into a Registration Rights
Agreement with certain stockholders dated August 26, 1996 (the "Prior
Registration Rights Agreement").

     Pursuant to a Securities Purchase Agreement among the Company and the
purchasers listed thereto, dated the date hereof, the Company and the Investors
have entered into this Agreement to amend, restate and supersede the Prior
Registration Rights Agreement.

     2. Registration Under Securities Act, Etc.

     2.1 Registration on Request.

          (a) Request. Subject to Section 2.8 hereof, at any time and from time
to time upon the written request of Holders (the "Initiating Holders") of not
less than the Required Number of Shares that the Company effect the registration
under the Securities Act (other than pursuant to a Shelf Registration Statement)
of all or part of such Initiating Holders' Registrable Securities (provided that
the Company shall not be obligated to register less than the Required Number of
Shares pursuant to such request), the Company will promptly give written notice
of such requested registration to all registered Holders, and thereupon the
Company will use its best efforts to effect the registration under the
Securities Act of:

               (i) the Registrable Securities (representing not less than the
     Required Number of Shares) which the Company has been so requested to
     register by such Initiating Holders, and

               (ii) all other Registrable Securities which the Company has been
     requested to register by the Holders thereof (such Holders together with
     the Initiating Holders are hereinafter referred to as the "Selling
     Holders") by

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     written request given to the Company within 20 days after the giving of
     such written notice by the Company, all to the extent required to permit
     the disposition of the Registrable Securities so to be registered.

          (b) Registration of Other Securities. Whenever the Company shall
effect a registration pursuant to this Section 2.1 in connection with an
underwritten offering by one or more Selling Holders, no securities other than
Registrable Securities shall be included among the securities covered by such
registration unless (i) the managing underwriter of such offering shall have
advised each Selling Holder to be covered by such registration in writing that
the inclusion of such other securities would not adversely affect such offering
or (ii) the Selling Holders of not less than a majority of all Registrable
Securities to be covered by such registration shall have consented in writing to
the inclusion of such other securities.

          (c) Registration Statement Form. Registrations under this Section 2.1
shall be on such appropriate registration form of the Commission as shall be
selected by the Company.

          (d) Expenses. The Company will pay the Registration Expenses in
connection with any registration requested pursuant to this Section 2.1.

          (e) Effective Registration Statement. A registration requested
pursuant to this Section 2.1 shall not be deemed to have been effected:

               (i) unless a registration statement with respect thereto has
     become effective,

               (ii) if after it has become effective, such registration is
     interfered with by any stop order, injunction or other order or requirement
     of the Commission or other governmental agency or court for any reason not
     attributable to the Selling Holders and such registration has not
     thereafter become effective, or

               (iii) if the conditions to closing specified in the underwriting
     agreement, if any, entered into in connection with such registration are
     not satisfied or waived, other than by reason of a failure on the part of
     the Selling Holders.

          (f) Selection of Underwriters. The underwriter or underwriters of each
underwritten offering of the Registrable Securities shall be selected by the

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mutual agreement of the Company and the Selling Holders of a majority of the
Registrable Securities so to be registered.

          (g) Priority in Requested Registration. If the managing underwriter of
any underwritten offering shall advise the Company in writing (with a copy to
each Selling Holder) that, in its opinion, the number of securities requested to
be included in such registration exceeds the number which can be sold in such
offering within a price range acceptable to the Selling Holders of a majority of
the Registrable Securities requested to be included in such registration, the
Company will include in such registration, to the extent of the number which the
Company is so advised can be sold in such offering, Registrable Securities
requested to be included in such registration, pro rata among the Selling
Holders on the basis of the percentage of the Registrable Securities of such
Selling Holders requested so to be registered. In connection with any such
registration to which this Section 2.1(g) is applicable, no securities other
than Registrable Securities shall be covered by such registration.

          (h) Limitations on Registration on Request. Notwithstanding anything
in this Section 2.1 to the contrary, the Company shall not be required to
effect, in the aggregate pursuant to this Section 2.1, without regard to the
Holder making such request, more than two registrations during any twelve month
period.

     2.2 Incidental Registration.

          (a) Right to Include Registrable Securities. If the Company proposes
at any time to register any of its securities under the Securities Act (other
than a Shelf Registration Statement) by registration on Forms S-1, S-2 or S-3 or
any successor or similar form(s) (except registrations on such Forms or similar
form(s) solely for registration of securities in connection with an employee
benefit plan or dividend reinvestment plan or a merger, reorganization, or
consolidation), whether or not for sale for its own account, it will, subject to
Section 2.8 hereof, each such time give prompt written notice to all registered
Holders of its intention to do so and of such Holders' rights under this Section
2.2. Upon the written request of any such Holder (a "Requesting Holder") made as
promptly as practicable and in any event within 20 days after the receipt of any
such notice (10 days if the Company states in such written notice or gives
telephonic notice to all registered Holders , with written confirmation to
follow promptly thereafter, that (i) such registration will be on Form S-3 and
(ii) such shorter period of time is required because of a planned filing date)
(which request shall specify the Registrable Securities intended to be disposed
of by such Requesting Holder), the Company will, subject to Section 2.8 hereof,
use its

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best efforts to effect the registration under the Securities Act of all
Registrable Securities which the Company has been so requested to register by
the Requesting Holders thereof; provided, that if, at any time after giving
written notice of its intention to register any securities and prior to the
effective date of the registration statement filed in connection with such
registration, the Company shall determine for any reason not to register or to
delay registration of such securities, the Company may, at its election, give
written notice of such determination to each Requesting Holder and (i) in the
case of a determination not to register, shall be relieved of its obligation to
register any Registrable Securities in connection with such registration (but
not from any obligation of the Company to pay the Registration Expenses in
connection therewith), without prejudice, however, to the rights of any Holder
or Holders entitled to do so to request that such registration be effected as a
registration under Section 2.1 and (ii) in the case of a determination to delay
registering, shall be permitted to delay registering any Registrable Securities,
for the same period as the delay in registering such other securities. No
registration effected under this Section 2.2 shall relieve the Company of its
obligation to effect any registration upon request under Section 2.1. The
Company will pay all Registration Expenses in connection with registration of
Registrable Securities requested pursuant to this Section 2.2.

          (b) Priority in Incidental Registrations. If the managing underwriter
of any underwritten offering shall inform the Company (or, in the case of a
secondary offering, the selling stockholders initiating such offering) of its
belief that the number or type of Registrable Securities requested to be
included in such registration would materially adversely affect such offering,
then the Company will include in such registration, to the extent of the number
and type which the Company is (or the selling stockholders initiating such
offering are) so advised can be sold in (or during the time of) such offering,
first, all securities proposed by the Company (or, in the case of a secondary
offering, the selling stockholders initiating such offering) to be sold for its
(or their) own account, and second, such Registrable Securities and any other
securities of the Company requested to be included in such registration, pro
rata among all such Holders on the basis of the estimated gross proceeds of the
securities of such Holders requested to be so included.

          (c) Selection of Managing Underwriter. The managing underwriter of any
underwritten offering pursuant to this Section 2.2 shall be selected by the
Company at its sole discretion.

     2.3 Registration Procedures. If and whenever the Company is required to use
its best efforts to effect the registration of any Registrable Securities under
the

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Securities Act as provided in Section 2.1, 2.2 or 2.8, the Company will as
expeditiously as possible:

          (a) in the case of a registration pursuant to Section 2.1 or 2.2,
prepare and (as soon as practicable, and in any event within 75 days in the case
of Form S-1 or S-2 and 30 days in the case of a registration requested on Form
S-3 after the end of the period within which requests for registration may be
given to the Company) file with the Commission the requisite registration
statement to effect such registration and thereafter use its best efforts to
cause such registration statement to become effective; provided, that the
Company may discontinue any registration of its securities which are not
Registrable Securities (and, under the circumstances specified in Section
2.2(a), its securities which are Registrable Securities) at any time prior to
the effective date of the registration statement relating thereto;

          (b) prepare and file with the Commission such amendments and
supplements to such registration statement and the prospectus used in connection
therewith as may be necessary to keep such registration statement effective and
to comply with the provisions of the Securities Act with respect to the
disposition of all Registrable Securities covered by such registration statement
for such period as shall be required for the disposition of all of such
Registrable Securities, provided, that in the case of a registration pursuant to
Section 2.1 or 2.2, such period need not exceed 90 days;

          (c) furnish to each seller of Registrable Securities covered by such
registration statement, such number of conformed copies of such registration
statement and of each such amendment and supplement thereto (in each case
including all exhibits), such number of copies of the prospectus contained in
such registration statement (including each preliminary prospectus and any
summary prospectus) and any other prospectus filed under Rule 424 under the
Securities Act, in conformity with the requirements of the Securities Act, and
such other documents, as such seller may reasonably request;

          (d) use its best efforts:

               (i) to register or qualify all Registrable Securities and other
     securities covered by such registration statement under such other
     securities or blue sky laws of such states of the United States of America
     where an exemption is not available and as the sellers of Registrable
     Securities covered by such registration statement shall reasonably request;

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               (ii) to keep such registration or qualification in effect for so
     long as such registration statement remains in effect; and

               (iii) to take any other action which may be reasonably necessary
     or advisable to enable such sellers to consummate the disposition in such
     jurisdictions of the securities to be sold by such sellers, except that
     the Company shall not for any such purpose be required to qualify generally
     to do business as a foreign corporation in any jurisdiction wherein it
     would not but for the requirements of this subdivision (d) be obligated to
     be so qualified or to consent to general service of process in any such
     jurisdiction;

          (e) use its best efforts to cause all Registrable Securities covered
by such registration statement to be registered with or approved by such other
federal or state governmental agencies or authorities as may be necessary in the
opinion of counsel to the Company and counsel to the seller or sellers thereof
to consummate the disposition of such Registrable Securities;

          (f) in the case of a registration pursuant to Section 2.1 or 2.2,
furnish to each seller of Registrable Securities a signed counterpart of (i) an
opinion of counsel for the Company and (ii) a "comfort" letter signed by the
independent public accountants who have certified the Company's financial
statements included or incorporated by reference in such registration statement
covering substantially the same matters with respect to such registration
statement (and the prospectus included therein) and, in the case of the
accountant's comfort letter, with respect to events subsequent to the date of
such financial statements, as are customarily covered in opinions of issuer's
counsel and in accountant's comfort letters delivered to the underwriters in
underwritten public offerings of securities (and dated the dates such opinions
and comfort letters are customarily dated) and, in the case of the accountant's
comfort letter, such other financial matters, and in the case of the legal
opinion, such other legal matters, as the sellers of a majority of the
Registrable Securities covered by such registration statement, or the
underwriters, may reasonably request;

          (g) notify each seller of Registrable Securities covered by such
registration statement at any time when a prospectus relating thereto is
required to be delivered under the Securities Act, upon discovery that, or upon
the happening of any event as a result of which, in the judgment of the Company,
the prospectus included in such registration statement, as then in effect,
includes an untrue statement of a material fact or omits to state any material
fact required to be stated therein or necessary to make the statements therein
not misleading, in the light of the circum-

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stances under which they were made, and at the request of any such seller
promptly prepare and furnish to it a reasonable number of copies of a supplement
to or an amendment of such prospectus as may be necessary so that, in the
judgment of the Company, as thereafter delivered to the purchasers of such
securities, such prospectus shall not include an 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 not misleading in the light of the circumstances
under which they were made;

          (h) otherwise use its best efforts to comply with all applicable rules
and regulations of the Commission, and make available to its security holders,
as soon as reasonably practicable, an earnings statement covering the period of
at least twelve months, but not more than eighteen months, beginning with the
first full calendar month after the effective date of such registration
statement, which earnings statement shall satisfy the provisions of Section
11(a) of the Securities Act and Rule 158 promulgated thereunder, and promptly
furnish to each such seller of Registrable Securities a copy of any amendment or
supplement to such registration statement or prospectus;

          (i) provide and cause to be maintained a transfer agent and registrar
(which, in each case, may be the Company) for all Registrable Securities covered
by such registration statement from and after a date not later than the
effective date of such registration; and

          (j) use its best efforts to list all Registrable Securities covered by
such registration statement on any national securities exchange or national
quotations system on which Registrable Securities of the same class covered by
such registration statement are then listed.

          The Company may require each seller of Registrable Securities as to
which any registration is being effected to furnish the Company in writing as
promptly as reasonably practicable such information regarding such seller and
the distribution of such securities as the Company may from time to time
reasonably request in writing.

          Each Holder agrees that upon receipt of any notice from the Company of
the happening of any event of the kind described in subdivision (g) of this
Section 2.3, such Holder will forthwith discontinue such Holder's disposition of
Registrable Securities pursuant to the registration statement relating to such
Registrable Securities until such Holder's receipt of the copies of the
supplemented or amended

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prospectus contemplated by subdivision (g) of this Section 2.3 and, if so
directed by the Company, will deliver to the Company (at the Company's expense)
all copies, other than permanent file copies, then in such Holder's possession,
of the prospectus relating to such Registrable Securities current at the time of
receipt of such notice.

     2.4 Underwritten Offerings.

          (a) Requested Underwritten Offerings. If requested by the underwriters
for any underwritten offering by Holders pursuant to a registration requested
under Section 2.1, the Company will enter into an underwriting agreement with
such underwriters for such offering, such agreement to be reasonably
satisfactory in substance and form to the Company, each such Holder and the
underwriters and to contain such representations and warranties by the Company
and such other terms as are generally prevailing in agreements of that type,
including, without limitation, indemnities to the effect and to the extent
provided in Section 2.7. The Holders of the Registrable Securities proposed to
be distributed by such underwriters will cooperate with the Company in the
negotiation of the underwriting agreement and will give consideration to the
reasonable suggestions of the Company regarding the form thereof. Such Holders
to be distributed by such underwriters shall be parties to such underwriting
agreement and may, at their option, require that any or all of the
representations and warranties by, and the other agreements on the part of, the
Company to and for the benefit of such underwriters shall also be made to and
for the benefit of such Holders and that any or all of the conditions precedent
to the obligations of such underwriters under such underwriting agreement be
conditions precedent to the obligations of such Holders . Any such Holder shall
not be required to make any representations or warranties to or agreements with
the Company or the underwriters other than representations, warranties or
agreements regarding such Holder, such Holder's Registrable Securities, such
Holder's intended method of distribution and any other representations required
by law.

          (b) Incidental Underwritten Offerings. If the Company proposes to
register any of its securities under the Securities Act as contemplated by
Section 2.2 and such securities are to be distributed by or through one or more
underwriters, the Company will, subject to Section 2.8 hereof, if requested by
any Requesting Holder arrange for such underwriters to include all the
Registrable Securities to be offered and sold by such Requesting Holder among
the securities of the Company to be distributed by such underwriters. The
Holders of Registrable Securities to be distributed by such underwriters shall
be parties to the underwriting agreement between the Company and such
underwriters and may, at their option, require that

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any or all of the representations and warranties by, and the other agreements on
the part of, the Company to and for the benefit of such underwriters shall also
be made to and for the benefit of such Holders and that any or all of the
conditions precedent to the obligations of such underwriters under such
underwriting agreement be conditions precedent to the obligations of such
Holders. Any such Requesting Holder shall not be required to make any
representations or warranties to or agreements with the Company or the
underwriters other than representations, warranties or agreements regarding
such Requesting Holder, such Requesting Holder's Registrable Securities and such
Requesting Holder's intended method of distribution or any other representations
required by law. Notwithstanding the foregoing provisions of this Section
2.4(b), the Company need not include any Registrable Securities of any such
Requesting Holder in an underwritten offering of the Company's securities if the
inclusion of such Requesting Holder's securities, in the opinion of the managing
underwriter for such offering by the Company, might adversely affect such
offering by the Company.

          (c) Hold-back Agreements.

               (i) In the case of any underwritten public offering by the
     Company of shares of Common Stock, each Holder agrees not to effect any
     disposition (other than a disposition of Registrable Securities under such
     underwritten public offering or a bona fide pledge or a disposition to an
     Affiliate of such Holder who agrees to be bound by the provisions of this
     paragraph) (a "Disposition") of any Registrable Securities, and not to
     effect any such Disposition of any other equity security of the Company or
     of any security convertible into or exchangeable or exercisable for any
     equity security of the Company (in each case, other than as part of such
     underwritten public offering) during the 15 days prior to, and during the
     90-day period (or such longer period as may be reasonably requested by the
     underwriter of such offering) beginning on, the effective date of such
     registration statement (except as apart of such registration); provided
     that each Holder has received written notice of such registration at least
     15 days prior to such effective date.

               (ii) If any registration of Registrable Securities shall be in
     connection with an underwritten public offering, the Company agrees (x) not
     to effect any public sale or distribution of any of its equity securities
     or of any security convertible into or exchangeable or exercisable for any
     equity security of the Company (other than any such sale or distribution of
     such securities in connection with any merger or consolidation by the
     Company or

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     any subsidiary of the Company of the capital stock or substantially all the
     assets of any other person or in connection with an employee stock option
     or other benefit plan) during the 90 days prior to, and during the 180-day
     period beginning on, the effective date of such registration statement
     (except as part of such registration) and (y) that any agreement entered
     into after the date of this Agreement pursuant to which the Company issues
     or agrees to issue any privately placed equity securities shall contain a
     provision under which Holders of such securities agree not to effect any
     Disposition of any such securities during the period referred to in the
     foregoing clause (x) (except as part of such registration, if permitted).

     2.5 Preparation; Reasonable Investigation. In connection with the
preparation and filing of each registration statement under the Securities Act
pursuant to this Agreement, the Company will give the Holders of Registrable
Securities registered under such registration statement, their underwriters, if
any, and their respective counsel and accountants the opportunity to participate
in the preparation of such registration statement, each prospectus included
therein or filed with the Commission, and, to the extent practicable, each
amendment thereof or supplement thereto, and give each of them such access to
its books and records (to the extent customarily given to underwriters of the
Company's securities) and such opportunities to discuss the business of the
Company with its officers and the independent public accountants who have
certified its financial statements as shall be necessary, in the opinion of such
Holders' and such underwriters' respective counsel, to conduct a reasonable
investigation within the meaning of the Securities Act.

     2.6 Limitations, Conditions and Qualifications to Obligations Under
Registration Covenants. The obligation of the Company to use its best efforts to
cause the Registrable Securities to be registered under the Securities Act is
subject to the following limitations, conditions and qualifications.

          (a) The Company shall be entitled to postpone for a reasonable period
of time (but not exceeding 180 days, in the case of a registration pursuant to
Section 2.1 or 2.2, and 30 days in the case of a registration pursuant to
Section 2.8) the filing of any registration statement otherwise required to be
prepared and filed by it pursuant to Section 2.1, if the Company determines, in
its reasonable judgment, that such registration and offering (i) would interfere
with any financing, acquisition, merger, consolidation, material joint venture,
corporate reorganization or other material transaction involving the Company or
any of its Affiliates, or (ii) would require premature disclosure of any of the
foregoing transactions (or of the existence

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of negotiations, discussions or pending proposals with respect thereto) or of
any pending or threatened litigation, claim, assessment or governmental
investigation which would be material to the Company, and promptly gives the
Holders requesting registration thereof pursuant to Section 2.1 written notice
of such delay. If the Company shall so postpone the filing of a registration
statement, such Holders of Registrable Securities requesting registration
thereof pursuant to Section 2.1 shall have the right to withdraw the request for
registration by giving written notice to the Company within 30 days after
receipt of the notice of postponement and, in the event of such withdrawal, such
request shall not be counted for purposes of the requests for registration to
which Holders are entitled pursuant to Section 2.1 hereof.

          (b) The Company shall not be obligated to effect the registration of
Registrable Securities of any Holder pursuant to Section 2.1, 2.2 or 2.8 unless
such Holder consents to reasonable conditions imposed by the Company, including
without limitation:

               (i) conditions prohibiting the sale of shares by such Holder
     until the registration shall have been effective for a specified period of
     time;

               (ii) conditions requiring such Holder to comply with all
     prospectus delivery requirements of the Securities Act and with all
     anti-stabilization, anti-manipulation and similar provisions of Section 10
     of the Exchange Act and any rules issued thereunder by the Commission, and
     to furnish to the Company information about sales made in such public
     offering;

               (iii) conditions prohibiting such Holder from effecting the sale
     of shares upon receipt of telegraphic or written notice from the Company
     (until further notice) given to permit the Company to correct or update a
     registration statement or prospectus; and

               (iv) conditions requiring that at the end of the period during
     which the Company is obligated to keep the registration statement effective
     under Section 2.3(b) or 2.8(c), such Holder shall discontinue sales of
     shares pursuant to such registration statement upon receipt of notice from
     the Company of its intention to remove from registration the shares covered
     by such registration statement that remain unsold, and requiring such
     Holder to notify the Company of the number of Registrable Securities
     registered that remain unsold promptly upon receipt of notice from the
     Company.

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          (c) Holders shall use their reasonable best efforts to effect as wide
a distribution of such Registrable Securities as reasonably practicable, and in
no event shall any sale of Registrable Securities be made knowingly to (i) any
Person (including its Affiliates) or (ii) any Persons or entities which are to
the knowledge of such Holders (or to the knowledge of any underwriter for such
Holders) part of any "group" within the meaning of Regulation 13D of the
Exchange Act which includes such purchaser or any of its Affiliates that, after
giving effect to such sale, would beneficially own securities representing more
than 5% of the aggregate voting power of all outstanding voting securities of
the Company. The Holders of such Registrable Securities shall secure the
agreement of their underwriter or underwriters, if any, for such offering to
comply with the foregoing.

     2.7 Indemnification.

          (a) Indemnification by the Company. In the event of any registration
of any securities of the Company under the Securities Act, the Company will, and
hereby does, indemnify and hold harmless, in the case of any registration
statement filed pursuant to Section 2.1, 2.2 or 2.8, each seller of any
Registrable Securities covered by such registration statement, its directors,
officers, partners, agents and Affiliates and each other Person who participates
as an underwriter in the offering or sale of such securities and each other
Person, if any, who controls such seller or any such underwriter within the
meaning of the Securities Act (a "Controlling Person"), insofar as losses,
claims, damages or liabilities (or actions or proceedings, whether commenced or
threatened, in respect thereof) arise out of or are based upon any untrue
statement or alleged untrue statement of any material fact contained in any
registration statement under which such securities were registered under the
Securities Act, any preliminary prospectus, final prospectus or summary
prospectus contained therein, or any amendment or supplement thereto, or any
omission or alleged omission to state therein a material fact required to be
stated therein or necessary to make the statements therein in light of the
circumstances in which they were made not misleading, and the Company will
reimburse such seller and each such director, officer, partner, agent or
affiliate, underwriter and Controlling Person for any legal or any other
expenses reasonably incurred by them in connection with investigating or
defending any such loss, claim, liability, action or proceeding; provided, that
the Company shall not be liable in any such case to the extent that any such
loss, claim, damage, liability (or action or proceeding in respect thereof) or
expense arises out of or is based upon an untrue statement or alleged untrue
statement or omission or alleged omission made in such registration statement,
any such preliminary prospectus, final prospectus, summary prospectus, amendment
or

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supplement in reliance upon and in conformity with written information furnished
to the Company through an instrument executed by or on behalf of such seller or
underwriter, as the case may be, specifically stating that it is for use in the
preparation thereof; and provided further, that the Company shall not be liable
to any Person who participates as an underwriter in the offering or sale of
Registrable Securities or any other Person, if any, who controls such
underwriter within the meaning of the Securities Act, in any such case to the
extent that any such loss, claim, damage, liability (or action or proceeding in
respect thereof) or expense arises out of such Person's failure to send or give
a copy of the final prospectus, as the same may be then supplemented or amended,
to the Person asserting an untrue statement or alleged untrue statement or
omission or alleged omission at or prior to the written confirmation of the sale
of Registrable Securities to such Person if such statement or omission was
corrected in such final prospectus so long as such final prospectus, and any
amendments or supplements thereto, have been furnished to such underwriter. Such
indemnity shall remain in full force and effect regardless of any investigation
made by or on behalf of such seller or any such director, officer, partner,
agent or affiliate or Controlling Person and shall survive the transfer of such
securities by such seller.

          (b) Indemnification by the Sellers. As a condition to including any
Registrable Securities in any registration statement, the Company shall have
received an undertaking satisfactory to it from the prospective seller of such
Registrable Securities, to indemnify and hold harmless (in the same manner and
to the same extent as set forth in subdivision (a) of this Section 2.7) the
Company, and each director of the Company, each officer of the Company and each
other Person, if any, who controls the Company within the meaning of the
Securities Act (a "Company Controlling Person"), with respect to any statement
or alleged statement in or omission or alleged omission from such registration
statement, any preliminary prospectus, final prospectus or summary prospectus
contained therein, or any amendment or supplement thereto, if such statement or
alleged statement or omission or alleged omission was made in reliance upon and
in conformity with written information furnished to the Company through an
instrument duly executed by such seller specifically stating that it is for use
in the preparation of such registration statement, preliminary prospectus, final
prospectus, summary prospectus, amendment or supplement; provided, however,
that the liability of such indemnifying party under this Section 2.7(b) shall be
limited to the amount of proceeds received by such indemnifying party in the
offering giving rise to such liability. Such indemnity shall remain in full
force and effect, regardless of any investigation made by or on behalf

                                       13
<PAGE>   15

of the Company or any such director, officer or Company Controlling Person and
shall survive the transfer of such securities by such seller.

          (c) Notices of Claims, etc. Promptly after receipt by an indemnified
party of notice of the commencement of any action or proceeding involving a
claim referred to in the preceding subdivisions of this Section 2.7, such
indemnified party will, if a claim in respect thereof is to be made against an
indemnifying party, give written notice to the latter of the commencement of
such action; provided, however, that the failure of any indemnified party to
give notice as provided herein shall not relieve the indemnifying party of its
obligations under the preceding subdivisions of this Section 2.7, except to the
extent that the indemnifying party is actually prejudiced by such failure to
give notice. In case any such action is brought against an indemnified party,
unless in such indemnified party's reasonable judgment a conflict of interest
between such indemnified and indemnifying parties is reasonably likely to exist
in respect of such claim, the indemnifying party shall be entitled to
participate in and, to assume the defense thereof, jointly with any other
indemnifying party similarly notified to the extent that it may wish, with
counsel reasonably satisfactory to such indemnified party, and after notice from
the indemnifying party to such indemnified party of its election so to assume
the defense thereof, the indemnifying party shall not be liable to such
indemnified party for any legal or other expenses subsequently incurred by the
latter in connection with the defense thereof other than reasonable costs of
investigation unless in such indemnified party's reasonable judgment a conflict
of interest between such indemnified and indemnifying parties arises in respect
of such claim after the assumption of the defense thereof and the indemnified
party notifies the indemnifying party of such indemnified party's judgment and
the basis therefor. No indemnifying party shall be liable for any settlement of
any action or proceeding effected without its written consent, which consent
shall not be unreasonably withheld. No indemnifying party shall, without the
consent of the indemnified party, consent to entry of any judgment or enter into
any settlement which does not include as an unconditional term thereof the
giving by the claimant or plaintiff to such indemnified party of a release from
all liability in respect of such claim or litigation.

          (d) Contribution. If the indemnification provided for in this Section
2.7 shall for any reason be held by a court to be unavailable to an indemnified
party under subparagraph (a) or (b) hereof in respect of any loss, claim, damage
or liability, or any action in respect thereof, then, in lieu of the amount
paid or payable under subparagraph (a) or (b) hereof, the indemnified party and
the indemnifying party under subparagraph (a) or (b) hereof shall contribute to
the aggregate losses, claims,

                                       14
<PAGE>   16

damages and liabilities (including legal or other expenses reasonably incurred
in connection with investigating the same), (i) in such proportion as is
appropriate to reflect the relative fault of the Company and the prospective
sellers of Registrable Securities covered by the registration statement which
resulted in such loss, claims, damage or liability, or action in respect
thereof, with respect to the statements or omissions which resulted in such
loss, claim, damage or liability, or action in respect thereof, as well as any
other relevant equitable considerations or (ii) if the allocation provided by
clause (i) above is not permitted by applicable law, in such proportion as shall
be appropriate to reflect the relative benefits received by the Company and such
prospective sellers from the offering of the securities covered by such
registration statement. No Person guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any Person who was not guilty of such fraudulent
misrepresentation. Such prospective sellers' obligations to contribute as
provided in this subparagraph (d) are several in proportion to the relative
value of their respective Registrable Securities covered by such registration
statement and not joint. In addition, no Person shall be obligated to contribute
hereunder any amounts in payment for any settlement of any action or claim
effected without such Person's consent, which consent shall not be unreasonably
withheld.

          (e) Other Indemnification. Indemnification and contribution similar to
that specified in the preceding subdivisions of this Section 2.7 (with
appropriate modifications) shall be given by the Company and each seller of
Registrable Securities with respect to any required registration or other
qualification of securities under any Federal or state law or regulation of any
governmental authority other than the Securities Act.

          (f) Indemnification Payments. The indemnification and contribution
required by this Section 2.7 shall be made by periodic payments of the amount
thereof during the course of the investigation or defense, as and when bills are
received or expense, loss, damage or liability is incurred. In any case in which
it shall be judicially determined that a party is not entitled to
indemnification or contribution, any payments previously received by such party
hereunder shall be promptly reimbursed.

                                       15
<PAGE>   17

     2.8 Shelf Registration Statements.

          (a) Within 120 days of the date hereof, the Company shall have filed
with the Commission and shall use its best efforts to cause to be declared
effective within 180 days from the date hereof, a Shelf Registration Statement,
relating to the offer and sale of the Registrable Securities owned by the
Holders listed on Schedule A hereto.

          (b) The Company will use its best efforts to keep the Shelf
Registration Statement continuously effective in order to permit the prospectus
forming part thereof to be usable by such Holders for a period of three years
from the date such Shelf Registration Statement is first declared effective by
the Commission, or for such shorter period that will terminate when all
Registrable Securities covered by such Shelf Registration Statement have been
sold pursuant thereto or cease to be outstanding or otherwise to be Registrable
Securities.

          (c) The Company will pay the Registration Expenses in connection with
any Shelf Registration Statement pursuant to this Section 2.8.

     3. Definitions. As used herein, unless the context otherwise requires, the
following terms have the following respective meanings (capitalized terms used
but not defined herein having the meanings set forth in the Stockholders
Agreement):

     "Affiliate" shall have the meaning ascribed to such term in Rule 12b-2 of
the General Rules and Regulations under the Exchange Act.

     "Commission" means the Securities and Exchange Commission or any other
federal agency at the time administering the Securities Act.

     "Exchange Act" means the Securities Exchange Act of 1934, as amended, or
any similar 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 a reference to the comparable section, if any, of any such similar
Federal statute.

     "Holder" means any holder of Registrable Securities.

                                       16
<PAGE>   18

     "Person" means a corporation, an association, a partnership, an
organization, a business, an individual, a governmental or political subdivision
thereof or a governmental agency.

     "Registration Expenses" means all expenses incident to the Company's
performance of or compliance with Section 2, including, without limitation, all
registration, filing and fees of the National Association of Securities Dealers,
Inc., all listing fees, all fees and expenses of complying with securities or
blue sky laws (including, without limitation, reasonable fees and disbursements
of counsel for the underwriters in connection with blue sky qualifications of
the Registrable Securities), all word processing, duplicating and printing
expenses, messenger and delivery expenses, the fees and disbursements of counsel
for the Company and of its independent public accountants, including the
expenses of "cold comfort" letters required by or incident to such performance
and compliance, any fees and disbursements of underwriters (including, without
limitation, fees and expenses of counsel to the underwriters) customarily paid
by issuers or sellers of securities and the reasonable fees and expenses of one
counsel to the Selling Holders (selected by Selling Holders representing at
least a majority of the Registrable Securities covered by such registration);
provided, however, that Registration Expenses shall exclude, and the sellers of
the Registrable Securities being registered shall pay, underwriters' fees and
underwriting discounts and commissions and transfer taxes in respect of the
Registrable Securities being registered.

     "Registrable Securities" means (i) the shares of Common Stock and the
shares of Common Stock issuable upon conversion of the Series A Preferred Stock
held or otherwise acquired by the Investors (including by way of issuance upon
exercise or conversion of any warrants or other securities) and (ii) any Common
Stock of the Company issuable or issued with respect to the Common Stock, the
Series A Preferred Stock and/or warrants or other securities referred to in
clause (i) by way of a merger, consolidation, stock split, stock dividend,
recapitalization of the Company or similar transaction. As to any particular
Registrable Securities, once issued such securities shall cease to be
Registrable Securities when (a) a registration statement with respect to the
sale of such securities shall have become effective under the Securities Act and
such securities shall have been disposed of in accordance with such
registration statement, (b) they shall have been sold as permitted by, and in
compliance with, Rule 144 (or successor provision) promulgated under the
Securities Act, (c) they shall have been otherwise transferred, new certificates
for them not bearing a legend restricting further transfer under the Securities
Act shall have been delivered by the Company and subsequent public distribution
of them

                                       17
<PAGE>   19

shall not require registration of them under the Securities Act, or (d) they
shall have ceased to be outstanding.

     "Required Number of Shares" means shares of Common Stock (or securities
convertible into or exchangeable or exercisable for Common Stock) representing a
total of 1,000,000 shares of Common Stock, subject to adjustment as provided in
Section 12.

     "Securities Act" means the Securities Act of 1933, as amended, or any
similar Federal statute, and the rules and regulations of the Commission
thereunder, all as the same shall be in effect at the time. References to a
particular section of the Securities Act of 1933, as amended, shall include a
reference to the comparable section, if any, of any such similar Federal
statute.

     "Shelf Registration Statement" means either Shelf Registration Statement
No. 1 or Shelf Registration Statement No. 2.

     "Shelf Registration Statement" shall mean a "shelf" registration statement
of the Company filed pursuant to Section 2.8, on an appropriate form under Rule
415 under the Securities Act, or any similar rule that may be adopted by the
Commission, and all amendments and supplements to such registration statement,
including post-effective amendments, in each case including the prospectus
contained therein, all exhibits thereto and all material incorporated by
reference therein.

     "Stockholders Agreement" shall mean the Amended and Restated Stockholders
Agreement dated the date hereof between the Company and the stockholders listed
on the signature pages thereof.

     4. Rule 144. The Company shall take all actions reasonably necessary to
enable Holders of Common Stock or Series A Preferred Stock to sell such
securities without registration under the Securities Act within the limitation
of the exemptions provided by (a) Rule 144 under the Securities Act, as such
Rule may be amended from time to time, or (b) any similar rule or regulation
hereafter adopted by the Commission including, without limiting the generality
of the foregoing, filing on a timely basis all reports required to be filed by
the Exchange Act. Upon the request of any Holder of Common Stock or Series A
Preferred Stock, the Company will deliver to such Holder a written statement as
to whether it has complied with such requirements.

                                       18
<PAGE>   20

     5. Amendments and Waivers. This Agreement may be amended with the consent
of the Company and the Company may take any action herein prohibited, or omit to
perform any act herein required to be performed by it, only if the Company shall
have obtained the written consent to such amendment, action or omission to act,
of :

          (i) the Holders of at least a majority of the Registrable Securities
(calculated on a fully diluted basis);

          (ii) GE Capital Equity Investments, Inc. (collectively, with General
Electric Capital Corporation, "GECC"), in the event GECC beneficially owns at
least 2,000,000 shares of Registrable Securities; and

          (iii) TH Lee.Putnam Internet Partners, L.P. and TH Lee.Putnam Internet
Parallel Partners, L.P. (collectively with their affiliates, "THLi"), in the
event THLi beneficially owns at least 2,000,000 shares of Registrable
Securities.

Each beneficial owner of any Registrable Securities at the time or thereafter
outstanding shall be bound by any consent authorized by this Section 5, whether
or not such Registrable Securities shall have been marked to indicate such
consent.

     6. Nominees for Beneficial Owners. In the event that any Registrable
Securities are held by a nominee for the beneficial owner thereof, the
beneficial owner thereof may, at its election in writing delivered to the
Company, be treated as the Holder of such Registrable Securities for purposes of
any request or other action by any Holder or Holders pursuant to this Agreement
or any determination of any number or percentage of Registrable Securities held
by any Holder or Holders contemplated by this Agreement. If the beneficial owner
of any Registrable Securities so elects, the Company may require assurances
reasonably satisfactory to it of such owner's beneficial ownership of such
Registrable Securities.

     7. Notices. All communications provided for hereunder shall be sent by
courier or other overnight delivery service, shall be effective upon receipt,
and shall be addressed as follows:

          (a) if to an Investor, at such address as the Investor shall have
furnished to the Company in writing;

                                       19
<PAGE>   21

          (b) if to any other Holder , at the address that such Holder shall
have furnished to the Company in writing, or, until any such other holder so
furnishes to the Company an address, then to and at the address of the last
Holder of such Registrable Securities who has furnished an address to the
Company; or

          (c) if to the Company, addressed to it at Krause's Furniture, Inc. 200
North Berry Street, Brea, CA 92821-3903, Attention: Judith O. Lasker, Esq. or at
such other address as the Company shall have furnished to each Holder at the
time outstanding.

     8. Assignment; Calculation of Interests in Registrable Securities.

          (a) This Agreement shall be binding upon and inure the benefit of and
be enforceable by the parties hereto and, with respect to the Company, its
respective successors and assigns and, with respect to the Investors, any
beneficial owner of any Registrable Securities, subject to the provisions
respecting the minimum number or proportion of shares of Registrable Securities
required in order to be entitled to certain rights, or take certain actions,
contained herein.

          (b) All references to Registrable Securities shall be 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; provided, that any proportion of the
Registrable Securities necessary to be determined in connection with a specific
registration shall be calculated based upon the number of Registrable Securities
participating in such registration only (assuming any shares of Series A
Preferred Stock had been converted into shares of Common Stock.)

     9. Descriptive Headings. The descriptive headings of the several sections
and paragraphs of this Agreement are inserted for reference only and shall not
limit or otherwise affect the meaning hereof.

     10. 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")

                                       20
<PAGE>   22

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.

     11. No Inconsistent Agreements. The Company will not hereafter enter into
any agreement with respect to its securities which is inconsistent with the
rights granted to the Holders in this Agreement.

     12. Recapitalizations, etc. In the event that any capital stock or other
securities are issued in respect of, in exchange for, or in substitution of, any
Registrable Securities by reason of any reorganization, recapitalization,
reclassification, merger, consolidation, spin-off, partial or complete
liquidation, stock dividend, split-up, sale of assets, distribution to
stockholders or combination of the shares of Registrable Securities or any other
change in the Company's capital structure, appropriate adjustments shall be made
in this Agreement so as to fairly and equitably preserve, to the extent
practicable, the original rights and obligations of the parties hereto under
this Agreement. At the request of the Selling Holders of a majority of
Registrable Securities in connection with any registration pursuant to Section
2.1 hereof, the Company will effect such adjustments to the outstanding Common
Stock, by way of stock split or stock dividend as the Selling Holders may
reasonably request to facilitate the registration and sale of the Common Stock.

     13. Attorneys' Fees. In any action or proceeding brought to enforce any
provision of this Agreement, or where any provision hereof is validly asserted
as a defense, the prevailing party to such action or proceeding shall be
entitled to recover reasonable attorneys' fees in addition to any other
available remedy.

                                       21
<PAGE>   23

     14. Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be deemed an original, but all such
counterparts shall together constitute one and the same instrument.

                                       22
<PAGE>   24

     IN WITNESS WHEREOF, the parties have caused this Registration Rights
Agreement to be executed and delivered by their respective officers thereunto
duly authorized as of the date first above written.

                                         KRAUSE'S FURNITURE, INC.

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

<PAGE>   25

                                         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>   26

                                         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:
                                            Title:

<PAGE>   27

                                         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

<PAGE>   28

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

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

                                         KUWAIT INVESTMENT PROJECTS COMPANY

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

                                         ATCO HOLDINGS, LTD.

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

                                         ATCO DEVELOPMENT, INC.

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

<PAGE>   29

                                         PILOT HOLDINGS, L.P.

                                         By: SHED INVESTMENTS, LLC, its General
                                             Partner

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

<PAGE>   30

                                         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>   31

                                         DR. PHILIP M. HAWLEY, JR.

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

                                         PHILIP M. HAWLEY

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

<PAGE>   32

                                         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>   33

                                                                      SCHEDULE A

Ascend Partners, L.P.
Larry Black
Branagh Revocable Trust
Matthew William Clarke - IRA
Sanford J. Colen
Aaron J. Colen, UTMA, CA
Elyse L. Colen, UTMA, CA
Sara K. Cox
John Davies
Diamond A. Partners, L.P.
J. Steven Emerson
Emily Fairbairn - IRA
Malcolm Fairbairn - IRA
William T. and Kathleen P. Gibson
Jonathan & Nancy Glaser Family Trust
George P. Hawley
Allison Booth Hawley Trust I
Caitlin Hale Hawley Trust I
Hawley Family Trust
Maureen Erin Hawley Trust I
Shannon Follen Hawley Trust I
Philip M. Hawley
Dr. Philip Hawley, Jr.
Victor F. Hawley
Richard Hicks
Kathryn Jergens Trust
Diane Johnson
Richard M. Keller
Stephen M. Keller
Stephen F. Keller Professional Corporation Defined Benefit Plan
Paul Kessler
Sidney Kimmel
Theodore D. Konopisos
Peter Lamm
Robert London
Jeffrey S. Morgan
The Muhl Family Trust
Pacific Security Group, Inc.

<PAGE>   34

Pilot Holdings, L.P.
Pointe Investments Capital, Ltd.
Pollat, Evans & Co., Inc.
Kevin and Erin Przybocki
Charles B. Runnels, Jr.
Charles B. Runnels, III
G. Tyler Runnels.
Lord Robin Russell
Timothy Michael Wallace
Wave Enterprises, Inc.
Ira Weingarten
J.D. Yates
Zaxis Partners, L.P.

                                 Schedule A - 2<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

                                       B-1

<PAGE>   52

                                   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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