What exactly is digital M&A and how does it compare with garden-variety deal making? The buzz in the world of mergers and acquisitions these days around technology and digital businesses. BCG latest report conculded that one out of every five transactions has a clear link to some form of technology.

In one of McKinsey's latest podcast two of the firm's partners discuss the various sides of digital M&A. Digital M&A includes a company buying analytics, skills, and software to improve how they make their product. Secondly, firms are buying sensors or Internet of Things applications and put them into the products to make their products better and future-proof. Lastly, social-orientated companies that are dealing with Uber- or AirBnb-like business models and all other types of online marketing.

Fundamentally, the biggest difference between regular and digital M&A is that it is very hard to value a digital target company. An industrial company buying a small industrial company will look at a stand-alone intrinsic valuation, maybe using a discounted cash flow. They will look at cross-sell and cost synergies to arrive at the value of a company to them and be able to set a price. However, in digital M&A, particularly if it is around a new business model, there is uncertainty where you are creating, potentially, a whole new profit-and-loss statement that is unproven. But even in the case where you are just acquiring a capability to improve your production or efficiency, the value of the company is going to be based on a different methodology. A traditional method is company A is buying company B, which allows company A to possibly cut costs and advance their product range, which in turn offers them a discounted-cash-flow value that ideally sits below the price tag. In Digital M&A you need the business plan first, and then you figure out how to fill it up. It is less about a single deal and more about how much you can spend to get the whole business going.

Whether it is a business model or a capability internally, you need to build a P&L and an operating plan so you can understand what the value at stake is. Then you need to figure out how much internal capability you are going to have to invest in versus what the contribution is of buying a the target. It is going to be a judgment call as to whether buying capabilities will either reduce the cost or increase the speed by which you can achieve the business objectives. Like we saw in tech M&A and software M&A decades ago, metrics around like a million dollars per engineer are more common than anything that os tied to the target company’s P&L or revenue. It feels like digital M&A is a broader investment in finding the right skills, people and ideas than classic M&A target hunting. In return, digital companies are mostly young and would welcome the benefit of mature companies and their processes. So traditional finance, recruiting, even operational skills should be selectively integrated to help these companies so they can focus on their innovation, instead adding additional administrative burdens.