What Is IFRS 2 and Why Does It Apply to Your UAE Company?

IFRS 2 (Share-Based Payment) is the International Financial Reporting Standard that governs how companies account for payments made in shares or share options. It was adopted in the UAE as part of the UAE's alignment with IFRS for financial statement preparation across mainland companies, DIFC entities, ADGM entities, and free zone companies reporting under IFRS.

The core requirement under IFRS 2 is straightforward: when a company grants share options or restricted shares to employees, directors, or advisors in exchange for their services, the fair value of those instruments must be measured at the grant date and recognised as an expense in the income statement over the vesting period.

For UAE startups and growth companies with employee share option plans (ESOPs), this creates a direct accounting obligation. If your company grants options, you have a share-based payment charge that must be quantified, and that quantification requires a formal valuation.

Key IFRS 2 Definitions
  • Grant date: The date the ESOP agreement is reached and both parties understand the terms and conditions
  • Fair value: The amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm's length transaction
  • Vesting period: The period during which service conditions (and any performance conditions) must be met
  • Intrinsic value: The excess of the share's fair value over the exercise price (used as a measurement basis only in limited circumstances)
  • Grant date fair value: The value of the option at the grant date — this is the number that drives the P&L charge under IFRS 2

When Does a UAE Company Need an ESOP Valuation Report?

Not every company that grants options immediately requires a formal third-party IFRS 2 valuation report. The practical threshold in the UAE is typically triggered by one of the following:

  • Audit requirement: Your auditor (whether Big 4 or another firm) requires a third-party fair value support to sign off on the share-based payment charge in your financial statements
  • Capital raising: You are raising a Series A or later round and institutional investors require fully IFRS-compliant financial statements
  • Due diligence: An acquirer or investor is conducting financial due diligence and will scrutinise the share-based payment charge
  • IPO preparation: You are preparing for a listing on DFM, ADX, Nasdaq Dubai, or any other exchange and require PCAOB or IAASB-compliant audit support
  • Dispute resolution: A shareholder or employee disputes the exercise price or the number of options granted
  • UAE Corporate Tax: You require documentation of the share-based payment expense for UAE CT deductibility purposes

For very early-stage companies with no institutional investors and no Big 4 audit requirement, management may self-calculate the IFRS 2 charge using reasonable estimates. However, once institutional capital is involved — or when the company's accounts are subject to any audit — an independent report from a qualified valuation professional becomes effectively mandatory.

The Two Methods: Black-Scholes vs Binomial Model

IFRS 2 does not prescribe a specific valuation model. It requires that an option pricing model be used that takes into account: the exercise price, the expected life of the option, the current price of the underlying shares, the expected volatility of the share price, the expected dividends, and the risk-free interest rate for the expected life of the option.

In practice, two models dominate ESOP valuations under IFRS 2 in the UAE market:

Model When to Use Key Strength Limitation
Black-Scholes Standard ESOP schemes with simple vesting conditions and no early exercise flexibility Simple, transparent, widely accepted by UAE auditors Cannot handle market-based performance conditions or early exercise
Binomial (lattice) Complex schemes with market-based conditions, early exercise provisions, or reload features Flexible — can model complex payoff structures Requires more inputs and assumptions; harder to audit-trail
Monte Carlo TSR-based (total shareholder return) performance conditions or path-dependent vesting Handles complex path-dependent conditions Computationally intensive; less common for standard UAE ESOPs

For the majority of UAE ESOP schemes — a straightforward grant of options exercisable at a fixed price after a time-based vesting schedule — the Black-Scholes model is appropriate and will be accepted by UAE audit firms without challenge.

The Six Inputs to Black-Scholes for a UAE Private Company

The Black-Scholes formula requires six inputs. For UAE private companies, several of these require estimation because there is no observable market price for the company's shares:

1. Current Share Price (S)

For listed companies, this is the observable market price. For UAE private companies, this is the fair market value of one share at the grant date — which may itself require a business valuation. This is often the most significant driver of the IFRS 2 charge and the most frequently challenged assumption in an audit context.

2. Exercise Price (K)

The price at which the option holder can purchase the share. This is a contractual term set in the ESOP agreement. Some UAE companies set this at the current fair market value (at-the-money options), some set it below market value (in-the-money), and some set it at a nominal amount (AED 1 or USD 0.01).

3. Expected Term (T)

The expected time from grant date to exercise. This is not the same as the contractual life of the option. IFRS 2 guidance suggests using a simplified expected term calculation: the average of the vesting date and the expiry date. For a 4-year vest with a 10-year contractual term, the expected term would typically be 7 years.

4. Expected Volatility (σ)

The single most technically challenging input for UAE private companies. Since there is no historical share price to derive volatility from, expected volatility must be estimated from:

  • The historical volatility of a peer group of publicly listed comparable companies in the same sector and geography (GCC-listed peers where available, MENA-listed peers where not, international peers as a final resort)
  • Implied volatility from traded options on comparable companies
  • Sector-specific volatility benchmarks derived from market data

This analysis must be documented in the valuation report and be defensible to auditors. Getting this input wrong — or selecting inappropriate comparables — is one of the most common errors in self-prepared ESOP valuations.

5. Risk-Free Rate (r)

The yield on a risk-free government security with a maturity matching the expected term of the option. For UAE-denominated ESOPs, the UAE government bond yield or the US Treasury rate is typically used (given the AED-USD peg). For 5-7 year expected terms, this has historically ranged from 3.5% to 5.5% depending on prevailing rates.

6. Expected Dividend Yield (q)

The expected annual dividend as a percentage of the share price. Most UAE startups and growth companies pay no dividends, so this is typically zero. For established businesses with a history of dividend payments, a non-zero dividend yield will reduce the option's fair value.

"The quality of an IFRS 2 valuation is determined entirely by the quality of the underlying share price estimate and the peer group selection for volatility. Get either of these wrong and the auditor will ask for a redo."

UAE-Specific Factors in ESOP Valuation

Several factors make ESOP valuation in the UAE and GCC distinct from other jurisdictions:

UAE Corporate Tax (9%)

Introduced with effect from June 2023, UAE Corporate Tax at 9% means that the share-based payment charge under IFRS 2 may be deductible for CT purposes, subject to the FTA's guidance on the timing of deductibility (grant date vs exercise date vs settlement date). This has a direct impact on the after-tax cost of the ESOP scheme to the company and should be factored into the scheme design.

End of Service Benefit (EOSB)

Under UAE labour law, employees are entitled to EOSB on departure. An ESOP scheme does not replace this entitlement. When valuing an ESOP for IFRS 2 purposes, it is important to confirm that the ESOP agreement does not inadvertently create an additional EOSB-like liability that would need to be recognised separately under IAS 19.

Free Zone vs Mainland Structures

UAE free zone companies (IFZA, RAKEZ, JAFZA, DIFC, ADGM) can issue share options to employees in various structures. The mechanics of option exercise — the share transfer process, the requirement for updated shareholders' registers, and the free zone authority approval requirements — affect the expected exercise pattern and should be reflected in the expected term assumption.

DIFC and ADGM Employee Share Schemes

Companies incorporated in the DIFC or ADGM operate under English law-based frameworks with specific requirements for employee share scheme documentation, employee consent, and disclosure. For DIFC entities, the DIFC Employment Law imposes specific requirements around changes to remuneration terms.

Vesting Conditions: Service vs Performance

IFRS 2 distinguishes between two types of vesting conditions, which are treated differently in the accounting:

  • Service conditions: Simply require the employee to remain employed for a period of time. These are standard time-based vesting conditions (e.g., 25% vest after year 1, 25% per year thereafter). Service conditions are reflected in the number of options expected to vest — but not in the grant date fair value calculation.
  • Performance conditions: Require a performance target to be met. Non-market performance conditions (e.g., revenue exceeding AED 50M) are also not reflected in fair value — instead, the number of options expected to vest is adjusted as performance expectations change. Market performance conditions (e.g., share price exceeding a threshold) must be factored into the option's fair value using a model that can handle market conditions — typically the binomial model or Monte Carlo simulation.
Common Errors in UAE ESOP Valuations
  • Using the exercise price as the share price (they are different concepts)
  • Using a publicly listed company's share price as the "comparable" — you need the unlisted company's own share value
  • Failing to adjust for the Discount for Lack of Marketability (DLOM) when estimating the underlying private share's fair value
  • Using a single volatility assumption without documenting the comparable selection process
  • Treating all vesting conditions as service conditions when some are market-based
  • Not updating the IFRS 2 charge when the scheme is modified or cancelled

What the IFRS 2 Valuation Report Contains

A professional IFRS 2 ESOP valuation report from Corvian Advisory will include:

  • The scope and purpose of the valuation (IFRS 2 fair value measurement)
  • Description of the ESOP scheme terms: grant date, exercise price, vesting schedule, contractual life, any performance conditions
  • Determination of the underlying share price at the grant date (this may require a separate business valuation if one has not been recently conducted)
  • Selection of the valuation model (Black-Scholes or binomial) with justification
  • Derivation of each input: share price, exercise price, expected term, expected volatility (including comparable selection), risk-free rate, dividend yield
  • Grant date fair value per option
  • Total IFRS 2 charge to be recognised, and the recognition schedule over the vesting period
  • Sensitivity analysis: showing how the fair value changes with reasonable changes in key assumptions
  • Disclosure note: the exact wording required for the IFRS 2 note to the financial statements

How Long Does an ESOP Valuation Take?

A standard IFRS 2 ESOP valuation engagement at Corvian Advisory typically takes 1–2 weeks from the date of receiving all required information. The key inputs we need are:

  • The ESOP scheme documentation or term sheet
  • The grant date (or expected grant date)
  • The most recent financial statements of the company
  • Any existing cap table or shareholder structure
  • Any previous business valuations or investor term sheets that establish a reference share price

If the business valuation of the underlying company also needs to be conducted (i.e., no recent independent valuation exists), the engagement takes 2–4 weeks and is priced accordingly.

ESOP Valuation Fees in the UAE

Corvian Advisory's ESOP valuation fees are fixed and agreed before work begins:

  • Standard ESOP valuation (single grant date, time-based vesting): From AED 8,000
  • ESOP valuation with underlying share price determination: From AED 18,000
  • Complex schemes (multiple grant dates, market-based conditions): Quoted on engagement scope
  • Annual refresh (existing scheme, update to new grant date): From AED 6,000

Need an IFRS 2 ESOP Valuation Report?

Corvian Advisory provides independent ESOP valuations under IFRS 2, accepted by UAE Big 4 audit firms. CFA-led. Fixed fees. Typically delivered within 1–2 weeks.

Request a Fixed-Fee Quote

ESOP Valuation UAE — Frequently Asked Questions

Do I need an ESOP valuation if my UAE company is still pre-revenue?+
Yes, if you have granted options or shares to employees, directors, or advisors and your company prepares IFRS-compliant financial statements, IFRS 2 applies regardless of whether the company has revenue. Pre-revenue status affects the underlying share price estimate (typically lower, often using a VC Method or Scorecard Method for the share valuation component), but does not exempt the company from the IFRS 2 requirement. For very early-stage companies before any institutional investment, a pragmatic approach is to agree a nil-value or nominal-value option scheme — but this needs to be done deliberately and documented, not assumed.
Can I use the last funding round price as the share price for IFRS 2?+
The most recent funding round price is commonly used as a starting point, but it is not automatically the fair market value for IFRS 2 purposes. Preferred shares issued in a funding round carry liquidation preferences, anti-dilution protections, and other rights that make their per-share price higher than the equivalent ordinary share value. IFRS 2 requires the fair value of the ordinary shares (or the specific class of shares underlying the options). An Option Pricing Model (OPM) or Probability Weighted Expected Return Method (PWERM) is typically used to allocate the total equity value to the ordinary shares, taking into account the preference waterfall. This is a technical exercise that Corvian Advisory performs as part of any ESOP valuation engagement.
What happens if we modify the ESOP scheme after the original grant?+
Under IFRS 2, a modification to the terms of a share-based payment arrangement (e.g., reducing the exercise price, extending the vesting period, adding performance conditions, or increasing the number of options) creates an additional IFRS 2 charge equal to the incremental fair value granted — i.e., the difference between the fair value of the modified option and the original option, both measured at the modification date. This incremental charge is recognised over the remaining vesting period. A new valuation is required at the modification date to quantify the incremental charge.