HKFRS 2 · Hong Kong
Share option and ESOP valuation
Share-based payment charges under HKFRS 2 for options, restricted share units, share awards and warrants — valued at grant date and evidenced for audit.
Why this is required
Under HKFRS 2, a company that grants share options or share awards to employees or service providers recognises an expense measured at the fair value of the instrument granted, not at the cost of issuing it. For equity-settled awards, fair value is measured at grant date and spread over the vesting period. For cash-settled awards, it is remeasured at each reporting date until settlement.
This catches companies out in two ways. First, the charge arises even though no cash leaves the business. Second, an unlisted company cannot read the input off a screen — the underlying share price, volatility and expected life all have to be estimated and defended.
What we value
- Employee share options and stock warrants, including tranches with different exercise prices
- Restricted share units and share awards, including awards sitting below several classes of preferred shares
- Performance-based and market-condition awards, where vesting depends on a share price or index target
- Options granted by unlisted companies, requiring a share price to be established first
- Cash-settled and phantom share schemes requiring remeasurement each period
- Modifications, cancellations and repricings, which trigger incremental fair value measurement
Models and why the choice matters
| Model | When it applies |
|---|---|
| Black-Scholes-Merton | Simple European-style options with a fixed term and no early exercise behaviour or performance condition |
| Binomial / trinomial lattice | American-style options, graded vesting, early exercise behaviour, or terms that change over the life of the award |
| Monte Carlo simulation | Market conditions — TSR targets, share price hurdles, path-dependent payouts — which a closed-form model cannot capture |
Applying Black-Scholes to an award with a market-based performance condition is a common finding in audit review. Where the award's payoff depends on the path of the share price rather than only its final level, simulation is the appropriate route.
The inputs auditors test hardest
- Underlying share price. For an unlisted company this needs its own valuation — often a backsolve from the most recent priced round, then allocation across share classes.
- Expected volatility. Derived from a peer group of listed comparables matched on industry, size and leverage, over a period matched to the expected life. The peer set has to be justified.
- Expected life. Not simply the contractual term. It reflects expected exercise behaviour, vesting structure and, where available, historical exercise patterns.
- Risk-free rate. Hong Kong Exchange Fund Note or equivalent government yield matched to the expected life.
- Dividend yield. Expected over the life of the award, not simply the current yield.
- Forfeiture assumptions. Estimated at grant and trued up to actual vesting outcomes.
Multiple grant dates mean multiple valuations. Each grant date is its own measurement event with its own inputs. A company that granted awards on four dates across two years needs four point-in-time analyses, not one. This is the single largest driver of scope and fee on these engagements — so tell us how many grant dates are involved when you enquire.
Cap tables with preferred shares
Where ordinary shares sit beneath one or more classes of preferred shares with liquidation preferences and conversion rights, the value of an ordinary share is not total equity divided by shares outstanding. Allocation through the contractual waterfall — commonly using an option pricing model, or Monte Carlo simulation where the structure is more complex — is required to establish what an ordinary share is worth before an option over it can be valued.
Common questions
Our company is not listed. How do you get a share price?
By valuing the equity first. Where there has been a recent priced funding round, a backsolve infers the total equity value consistent with what investors paid for the preferred shares, then allocates that value across share classes through the liquidation waterfall to arrive at an ordinary share value. Where there is no recent round, the equity is valued directly using income or market approaches and then allocated.
Where does volatility come from for an unlisted company?
From a peer group of listed comparables, selected on industry, business model, size and leverage, with historical volatility measured over a window matched to the expected life of the award. Where the subject company's leverage differs materially from the peers, the peer volatilities may be unlevered and relevered. The peer selection is documented, because it is usually the first thing an auditor questions.
We repriced options after a down round. What happens?
A repricing is a modification under HKFRS 2. The instrument is valued immediately before and immediately after the modification using consistent assumptions, and the incremental fair value is recognised in addition to the original grant-date charge — over the remaining vesting period, or immediately if the award is already vested. Two valuations at the modification date are required, not one.
Can you value awards for prior years we never recognised?
Yes, and it is a common request when a company is preparing for audit or an IPO for the first time. Each historical grant date is valued as at that date using information available then. We do this regularly for pre-IPO restructuring, where several years of grants need to be measured and the cumulative charge recognised.
Related valuation services
- Startup & Pre-IPO Valuation
- Convertible Bond & Preference Share Valuation
- Business Valuation
- Purchase Price Allocation
This page summarises how Valtech approaches this engagement type in Hong Kong. It is general information, not valuation, accounting, tax or legal advice for any specific entity. Scope and methodology are agreed in an engagement letter before work begins.
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