STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE

Our capital structure consisted of the following at December 31, 2013 and 2012:



		December 31,
		2013		2012
	Authorized	Total Issued		Total Issued
Common Stock
Common Stock	150,208,500	50,000		50,000
Class B Common Stock:
Class B-1	4,023,400	3,811,342		3,811,342
Class B-2	4,023,400	3,811,342		3,811,342
Class B-3	8,165,700	7,735,169		7,735,169
Class B-4	781,644	627,579		627,579
Total Class B Common Stock	16,994,144	15,985,432		15,985,432
Class C Common Stock	15,803,212	838,448		838,448
Class D Common Stock	16,994,144	—		—
Total Common Stock	200,000,000	16,873,880		16,873,880
Preferred Stock	100,000,000	—		—
Total	300,000,000	16,873,880		16,873,880
Less: Treasury stock		(41,659	)	—
Total issued and outstanding		16,832,221		16,873,880

Common Stock - Common Stock represents unrestricted, fully tradable, voting common stock. Upon liquidation, our assets are distributed on a pro rata basis, after payment in full of any liabilities and amounts due to preferred stockholders.

Holders of Class B, C, and D Common Stock generally have the same relative powers and preferences as the common stockholders, except for certain transfer restrictions, as follows:

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Class B Common Stock - The Class B common stock, which was issued in exchange for membership units of the Fund, the stock of the Manager or membership units of Holdings, is held by a custodian and divided into four separate series of Class B common stock. The Class B-1, B-2 and B-3 common stock are not eligible for conversion into common stock until, and subject to transfer restrictions that lapse upon, predetermined intervals of six, nine or 12 months following the earlier of (1) consummation of an initial public offering or (2)the 90th day following notice given by the board of directors not to pursue an initial public offering, in the case of each of the Class B-1, Class B-2 and Class B-3 common stock, respectively. If, at any time after the five-month anniversary of the consummation of an initial public offering, the closing price of IMH Financial Corporation’s common stock is greater than 125% of the offering price in an initial public offering for 20 consecutive trading days, all shares of Class B-1, Class B-2 and Class B-3 common stock will be convertible into shares of IMH Financial Corporation common stock that will not be subject to restrictions on transfer under the certificate of incorporation of IMH Financial Corporation. Each share of Class B-4 common stock shall be convertible to one share of Common Stock upon the four-year anniversary of the consummation of the Conversion Transactions. The transfer restrictions will terminate earlier if (1) any time after five months from the first day of trading on a national securities exchange, either the market capitalization (based on the closing price of IMH Financial Corporation common stock) or the book value of IMH Financial Corporation will have exceeded approximately $730.4 million (subject to upward adjustment by the amount of any net proceeds from new capital raised in an initial public offering or otherwise, and to downward adjustment by the amount of any dividends or distributions paid on membership units of the Fund or IMH Financial Corporation securities after the Conversion Transactions), or (2) after entering into an employment agreement approved by the compensation committee of IMH Financial Corporation, the holder of Class B common stock is terminated without cause, as this term is defined in their employment agreements as approved by the compensation committee of IMH Financial Corporation. In addition, unless IMH Financial Corporation has both (i) raised an aggregate of at least $50 million in one or more transactions through the issuance of new equity securities, new indebtedness with a maturity of no less than one year, or any combination thereof, and (ii) completed a listing on a national securities exchange, then, in the event of a liquidation of IMH Financial Corporation, no portion of the proceeds from the liquidation will be payable to the shares of Class B-4 common stock until such proceeds exceed approximately $730.4 million. All shares of Class B common stock automatically convert into Common Stock upon consummation of a change of control as defined in the certificate of incorporation. To provide additional incentive for holders of Class B common stock to remain longer-term investors, we agreed to pay, subject to the availability of legally distributable funds, a Special Dividend to Class B stockholders of $0.95 a share to all stockholders who have retained continuous ownership of their shares through the 12 month period following an initial public offering.

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Class C Common Stock – There is one series of Class C common stock which is also held by the custodian and will either be redeemed for cash or converted into shares of Class B common stock. Following the consummation of an initial public offering, we may, in our sole discretion, use up to 30% of the net proceeds from the offering (up to an aggregate of $50 million) to effect a pro rata redemption of Class C common stock (based upon the number of shares of Class C common stock held by each stockholder) at the initial public offering price, less selling commissions and discounts paid or allowed to the underwriters in the initial public offering. It is expected that the amount the stockholders of Class C common stock will receive per share will be less than the amount of their original investment in the Fund per unit. Any shares of Class C common stock that are not so redeemed will automatically convert into shares of Class B common stock as follows: 25% of the outstanding shares of Class C common stock will convert into shares of Class B-1 common stock, 25% will convert into shares of Class B-2 common stock and 50% will convert into shares of Class B-3 common stock.

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Class D Common Stock – If any holder of Class B common stock submits a notice of conversion to the custodian, but represents to the custodian that the holder has not complied with the applicable transfer restrictions, all shares of Class B common stock held by the holder will be automatically converted into Class D common stock and will not be entitled to the Special Dividend and will not be convertible into common stock until the 12-month anniversary of an IPO and, then, only if the holder submits a representation to the custodian that the applicable holder has complied with the applicable transfer restrictions in the 90 days prior to such representation and is not currently in violation. If any shares of Class B common stock owned by a particular holder are automatically converted into shares of Class D common stock, as discussed above, then each share of Class C common stock owned by the holder will convert into one share of Class D common stock.

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Preferred Stock – To the fullest extent permitted under Delaware law, our board of directors is authorized by resolution to divide and issue shares of preferred stock in series and to fix the voting powers and any designations, preferences, and relative, participating, optional or other special rights of any series of preferred stock and any qualifications, limitations or restrictions of the series as are stated and expressed in the resolution or resolutions providing for the issue of the stock adopted by the board of directors. In connection with the convertible note transaction in June 2011, we reserved approximately 7.9 million shares of Class A Preferred Stock for NW Capital upon conversion of the note payable and 1.4 million for the potential Rights Offering convertible debt issuance and related conversion.

Subject to prevailing market conditions and regulatory approvals, we ultimately intend to conduct an IPO of our common stock and we contemplate that the shares of the common stock of IMH Financial Corporation will eventually become traded on a national stock exchange. However, we are unable to determine the timing of an IPO at this time and there is no assurance that we will conduct an IPO. We do not plan to list the shares of the Class B, Class C or Class D common stock on any securities exchange or include the shares of Class B, Class C or Class D common stock in any automated quotation system, and no trading market for the shares of such classes of common stock is expected to develop.

Resignation of Chief Executive Officer and Sale of Stock

In connection with the NW Capital loan, effective June 7, 2011, Shane C. Albers, our initial CEO and founder, resigned from his position pursuant to the terms of a Separation Agreement and General Release (“Separation Agreement”). William Meris, our President, has also assumed the role of CEO.

Pursuant to the terms of the Separation Agreement between Mr. Albers and us, dated as of April 20, 2011, Mr. Albers received severance of a lump-sum cash payment of $550,000. In addition, a separate one-time payment of $550,000 was paid for our continued use of the mortgage banker’s license, for which Mr. Albers is the responsible person under applicable law, until the earlier of one year or such time as we have procured a successor responsible person under the license. In May 2012, we were issued a new mortgage banker license in the name of one of our subsidiaries from the Arizona Department of Financial Institutions. Mr. Albers also received $20,000 per month for full time transitional consulting services for an initial three month term, which was terminated upon expiration of the initial term. Mr. Albers also received reimbursement for up to $170,000, payable in equal portions for 12 months, in respect of ongoing services provided to him by a former employee, and an additional $50,000 for reimbursement by us of legal, accounting and other expenses incurred by Mr. Albers in connection with the Separation Agreement. Finally, we have agreed to pay certain health and dental premiums and other benefits of Mr. Albers for one year following his separation. All amounts paid or payable under this arrangement were expensed by us during the year ended December 31, 2011.

In connection with Mr. Albers’ resignation, we consented to the transfer of all of Mr. Albers’ holdings in the Company to an affiliate of NW Capital. As a result, the affiliate acquired 1,423 shares of Class B-1 common stock, 1,423 shares of Class B-2 common stock, 2,849 shares of Class B-3 common stock and 313,789 shares of Class B-4 common stock for $8.02 per share. Pursuant to the terms of the Separation Agreement, we deemed Mr. Albers’ resignation/separation to be “without cause,” and therefore the shares of Class B-4 common stock previously owned by Mr. Albers were no longer subject to the restrictions upon transfer applicable to Class B-4 common stock, but remain subject to all of the restrictions applicable to Class B-3 common stock as well as the additional dividend and liquidation subordination applicable to Class B-4 common stock. The amount by which the NW Capital affiliate paid in excess of the fair value of the common stock purchased resulted in our recording $1.2 million in compensation expense during the year ended December 31, 2011 in accordance with GAAP with the offsetting amount to be reported as a reduction in the associated debt’s interest expense over its corresponding term of five years using the effective interest method. This amount, net of related stock based compensation to the consultant described below, is reflected in the accompanying consolidated statement of cash flows as stock based compensation attributed to deferred financing costs.

Treasury Stock

As more fully described in note 14, in connection with the dismissal of an appeal of the Class settlement, during the year ended December 31, 2013, the Company entered into a settlement agreement and acquired 41,659 shares of the Company’s stock (comprised of 10,412 shares of Class B-1 common stock, 10,412 shares of Class B-2 common stock and 20,835 shares of Class B-3 common stock). Of the total payment made in connection with the settlement, approximately $0.2 million was allocated to the acquisition of stock representing the estimated fair value of such stock.

As more fully described in note 14, we expect to issue certain subordinated unsecured notes payable to participating shareholders in the first or second quarter of 2014 in exchange for approximately 1.2 million shares of common stock (the approximate subscription for which was determined as of the end of the offering period on March 20, 2014 and is subject to adjustment) pursuant to a legal settlement. As of December 31, 2013, we recorded $4.9 million as mezzanine equity, representing the estimated fair value of such shares determined to be $4.12 per share. We have presented this amount as the fair value of puttable shares pursuant to legal settlement in the accompanying consolidated balance sheet as of December 31, 2013, with an offsetting reduction of paid-in capital. Upon issuance of the notes payable and receipt of related stock, we will record the treasury stock in the first or second quarter of 2014. The actual amount of shares redeemed will be recorded in treasury stock when the notes are formally issued and stock acquired in the first or second quarter of 2014.

Share-Based Compensation

During the year ended December 31, 2011, our Board of Directors approved the grants of 14,114 shares of Class B-3 common shares to an employee and 50,000 common shares to a consultant in connection with the closing of the NW Capital loan. The weighted average fair value of the awards as of the grant dates was $3.95 per share and was determined based upon a valuation analysis performed by an independent consultant. There were no contingencies with respect to the issuance of these common shares. Compensation expense related to the issuance of the common stock to the employee in the amount of $47,000 was recognized during the year ended December 31, 2011, and the fair value of the common stock related to the consultant in the amount of $0.2 million was capitalized to deferred financing costs. No shares of stock were issued during the years ended December 31, 2013 or 2012.

During the year ended December 31, 2011, we granted 800,000 stock options to our executives, certain employees and certain consultants under our 2010 Stock Incentive Plan. During the years ended December 31, 2013 and 2012, we granted 40,000 and 5,000 of additional options, respectively, to certain employees. During the years ended December 31, 2013 and 2011, 34,445 and 23,333 options, respectively, were forfeited upon termination of certain employees. In addition, in connection with the termination of such employees, the board of directors approved the acceleration of vesting for 75,555 and 46,667 options during the years ended December 31, 2013 and 2012, respectively. The acceleration of vesting was treated as a modification and all incremental charges were expensed in the respective period. As of December 31, 2013, there were 787,222 options outstanding, of which 595,921 were vested and 191,301 were non-vested. As of December 31, 2012, there were 781,667, of which 350,294 were vested and 431,373 were non-vested. At December 31, 2013, 412,778 options were available for future grants. We accounted for the issuance of such options in accordance with applicable accounting guidance.

Stock options are reported based on the fair value of a share of the common stock, as determined by an independent consultant as our stock is not traded on an open exchange. The options have a contractual term of ten years. Certain stock option grants vest ratably on the first, second and third anniversaries of the date of grant, while other stock options vest ratably on a monthly basis over three years from the date of grant. The fair value of each stock option award was estimated on the date of grant using the Black-Scholes valuation model. For employee options, we used the simplified method to estimate the period of time that options granted are expected to be outstanding. Expected volatility is based on the historical volatility of our peer companies’ stock for the length of time corresponding to the expected term of the option. The expected dividend yield is based on our historical and projected dividend payments. The risk-free interest rate is based on the U.S. treasury yield curve on the grant date for the expected term of the option. The following weighted-average assumptions were used in calculating the fair value of stock options granted as of and for the year ended December 31, 2013 and 2012, using the Black-Scholes valuation model:



	Weighted Average
Expected term of options (in years)	6.9
Expected volatility factor	90	%
Expected dividend yield	2.7	%
Risk-free interest rate	2.2	%

A summary of stock option activity as of and for the years ended December 31, 2013 and 2012, is presented below:



	Shares		Exercise Price Per Share (*)		Remaining Contractual Term (*) (in years)	Aggregate Intrinsic Value (in millions)
Outstanding at December 31, 2011	776,667		$	9.58	9.5	$	—
Granted	5,000		$	4.51	4.5	$	—
Outstanding at December 31, 2012	781,667		$	9.55	8.5	$	—
Granted	40,000		$	7.39	9.5	$	—
Forfeited or expired	(34,445	)	$	—	—	$	—
Outstanding at December 31, 2013	787,222		$	9.44	7.7	$	—
Exercisable at December 31, 2013	595,921

*Weighted-average

The weighted-average grant date fair value of options granted during the years ended December 31, 2013, 2012 and 2011 was approximately $2.51 per option. As of December 31, 2013, there were 595,921 fully-vested options vested of which 200,071, 340,990 and 54,860 vested during the years ended December 31, 2013, 2012 and 2011, respectively. No options were exercised during the years ended December 31, 2013, 2012 or 2011. Net stock-based compensation expense relating to the issuance of options was $0.6 million for each of the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, there was approximately $0.5 million of unrecognized compensation cost related to non-vested stock option compensation arrangements granted under the 2010 Stock Incentive Plan that is expected to be recognized as a charge to earnings over a weighted-average vesting period of 0.62 years.

Employee Benefit Plan

The Company, through its human resource provider, participates in a 401(k) retirement savings plan that allows for eligible participants to defer compensation, subject to certain limitations imposed by the Code. The Company may provide a discretionary matching contribution of up to 4% of each participant's eligible compensation. During each of the years ended December 31, 2013, 2012 and 2011, the Company's matching contributions were approximately $0.1 million.

Net Loss Per Share

Basic net loss per common share is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding during the period, before giving effect to stock options or convertible securities outstanding, which are considered to be dilutive common stock equivalents. Diluted net loss per common share is calculated based on the weighted average number of common and potentially dilutive shares outstanding during the period after giving effect to convertible preferred stock and stock options. Due to the losses for the years ended December 31, 2013, 2012 and 2011, basic and diluted loss per common share were the same, as the effect of potentially dilutive securities would have been anti-dilutive. For December 31, 2013, 2012 and 2011, the only potentially dilutive securities, not included in the diluted loss per share calculation, consisted of 787,222, 781,667 and 776,667 stock options, respectively, and the NW Capital convertible note payable which were convertible into approximately 6.3 million, 6.0 million and 5.7 million shares of Series A Preferred Stock for December 31, 2013, 2012 and 2011, respectively (subject to increase upon NW Capital’s deferral of accrued interest), which are ultimately convertible into the same number of shares of our common stock. There were no other potentially dilutive securities for December 31, 2013, 2012 or 2011.

Dividends and Distributions

During the years ended December 31, 2013, 2012 and 2011, we declared dividends of $0.02 per share, $0.09 per share and $0.09 per share, respectively. We have not established a minimum distribution level and we may not be able to make any distributions at all. In addition, since we have not generated earnings in recent periods, some or all of our distributions may include a return of capital. All distributions will be made at the discretion of our board of directors and will depend on our earnings, our financial condition and other such factors as our board of directors may deem relevant from time to time, subject to the availability of legally available funds.

Moreover, under the provisions of the NW Capital loan, generally, no dividend may be paid on the common stock during any fiscal year unless all accrued dividends on the Series A preferred stock have been paid in full. However, the lender agreed to allow the payment of dividends to common stockholders for up to the first seven quarters following the loan closing in an annual amount of up to 1% of the net book value of the Company’s common stock as of the immediately preceding December 31. All available distributions under this provision have been made.