Employee share-based incentives are a powerful tool for European scale-ups, but they also introduce accounting and governance complexities that are often underestimated. This article explains what IFRS 2 requires in practice, highlights the most common pitfalls we see in venture-backed and co-investment transactions, and outlines how founders and CFOs can avoid unpleasant surprises during audits or due diligence. Read on for a practical guide to getting employee stock options right from the outset and strengthening investor confidence as your company scales.
The core IFRS 2 principle, in plain terms
IFRS 2 requires companies to recognise the fair value of equity awards granted to employees as an expense over the period in which the employees earn those awards, usually the vesting period. The fair value is measured at grant date, not at exercise, not at exit, and not when cash changes hands.
The fact that stock options are non-cash does not matter. From an IFRS perspective, equity is a form of remuneration, and remuneration must be recognised in the income statement.
For most European scale-ups, this means that stock options, RSUs, growth shares, and similar instruments create a recurring personnel expense long before any liquidity event.
Valuation, the first stumbling block
The most common mistake is either not valuing options at all, or valuing them incorrectly.
IFRS 2 requires the use of an option pricing model consistent with financial theory. In practice, this usually means Black-Scholes for simple option plans, or a binomial or lattice model where early exercise behaviour is relevant.
For private companies, the challenge is not the model itself but the inputs. Expected volatility must be estimated using comparable listed companies or relevant indices. Expected option life must reflect likely employee behaviour, not the legal maturity. Dividend yield is usually zero. Risk-free rates should match the currency and expected life of the option.
Auditors typically focus on volatility assumptions, expected life, and the justification for the underlying share value used at grant date. Using a recent funding round price without considering preference rights or structural differences between share classes is a frequent red flag.
The practical fix is straightforward. Document your assumptions, use consistent peer groups, and update your methodology only when facts change, not opportunistically.
Vesting, forfeitures, and why straight-line accounting often fails
Another frequent issue lies in how expenses are recognised over time.
Many option plans vest in tranches, for example 25 percent per year over four years. Under IFRS 2, each tranche must be treated as a separate award with its own vesting period. This leads to front-loaded expense recognition, not a straight-line profile.
Applying a simple total value divided by total years approach is usually incorrect and understates early-period costs.
Forfeitures add another layer. Options that do not vest because employees leave must not remain expensed. IFRS requires companies to adjust the number of awards expected to vest and reverse expense for awards that ultimately fail to vest due to service or non-market performance conditions.
Where scale-ups often go wrong is accelerating expense when employees leave, treating departures as cancellations rather than forfeitures. Under IFRS 2, a resignation typically results in reversal of unvested expense, not acceleration.
Performance conditions, market versus non-market
Performance conditions cause recurring confusion.
Market conditions, such as share price hurdles or total shareholder return targets, must be reflected in the grant-date fair value. Once granted, expense is not reversed if the market condition is not met, provided the employee completes the service period.
Non-market conditions, such as revenue targets, EBITDA milestones, or IPO events, are treated differently. They are not included in the fair value calculation. Instead, companies adjust expense based on the number of awards expected to vest.
This distinction matters. Reversing expense for a failed market condition, or failing to reverse for a failed non-market condition, is a common audit finding.
Modifications, repricing, and unintended accounting consequences
Down rounds, repricing of underwater options, extensions of exercise periods, or accelerated vesting on termination are all common in fast-growing companies.
From an accounting perspective, most of these actions are treated as modifications. If a modification benefits employees, for example by lowering the exercise price or extending the option life, IFRS 2 requires recognition of the incremental fair value as additional compensation.
Crucially, unfavourable modifications do not allow companies to reduce expense. The original grant-date fair value remains the minimum cost recognised.
Many scale-ups underestimate the accounting impact of seemingly commercial decisions taken to retain staff or resolve employee departures. The fix is to involve finance early, value the modification at the modification date, and explicitly quantify the incremental expense before approving changes.
Cross-border teams, group structures, and who books the cost
European scale-ups frequently operate with a holding company granting equity to employees of multiple subsidiaries.
Under IFRS 2, the entity receiving the employee’s services must recognise the expense, even if the shares are issued by the parent. In subsidiary accounts, this is treated as an equity-settled award with a capital contribution from the parent.
Failure to allocate expense to the correct entity, or double-counting it in both parent and subsidiary, is common in international groups.
Recharges between group entities further complicate matters. These are typically equity or capital transactions, not additional operating expenses, and should be treated accordingly.
Foreign currency effects, employer social taxes on option gains, and local payroll coordination add further complexity. These are manageable, but only if responsibilities and processes are clearly defined.
Why this matters for founders and investors
Share-based payments directly affect reported EBITDA, operating losses, and key performance metrics used in funding rounds and exits. Weak IFRS 2 accounting often surfaces late, during audits, due diligence, or IPO preparation, when corrections are costly and credibility is at stake.
Strong IFRS 2 discipline, by contrast, signals maturity. It shows investors that management understands the true cost of talent, that equity incentives are controlled rather than improvised, and that financial reporting can scale with the business.
Daniel Shear, Investment Analyst at Kylla Corporate Transactions, observes that in Kylla’s co-investment transactions, equity incentive structures are increasingly scrutinised by both founders and professional investors. “In a co-investment context, we regularly see that well-designed share-based incentive plans support alignment between management teams and incoming capital, and contribute to more robust governance over the long term. Conversely, weaknesses in IFRS 2 implementation often surface during due diligence and can complicate discussions around valuation and ongoing personnel costs. As I finalise my accountancy studies in the spring of 2026, this reinforces my view that European scale-ups benefit from applying the same level of rigour to share-based payment accounting as they do to any other material aspect of their financial reporting.”
Would EU Inc. Really Simplify IFRS 2
While the proposed 28th Regime, often referred to as EU Inc., would be a meaningful step forward for Europe’s venture ecosystem, it would not fundamentally remove the accounting complexity around employee equity incentives. A harmonised European corporate form would simplify legal structures, reduce the need for country-specific equity instruments, and limit forced plan modifications driven by local company law, all of which would indirectly make IFRS 2 implementation cleaner. However, the core challenges under IFRS 2, such as option valuation, vesting and forfeiture accounting, and the treatment of modifications and performance conditions, would remain unchanged, as IFRS is already applied consistently across Europe. In practice, EU Inc. would make equity plans easier to roll out and scale across borders, but it would not eliminate the need for robust IFRS 2 discipline, particularly given that employment tax and payroll differences across European jurisdictions would continue to drive complexity.
The takeaway
IFRS 2 is not just a technical accounting standard. It sits at the intersection of talent strategy, governance, valuation, and investor trust.
For European scale-ups, the highest-impact improvements are clear: robust grant-date valuations, disciplined vesting and forfeiture tracking, early assessment of modifications, and clear allocation of expense across group entities.
Getting this right early is far easier than fixing it under pressure later.
By: Daniel Schear
Investment Analyst
Kylla Corporate Transactions
