It’s not a good time to be a venture capitalist, especially a technology specialist. The bursting of the dotcom bubble has made billion-dollar IT companies comparatively worthless, while hundreds of smaller firms have also gone under. The number of IPOs – through which VCs often get a return on their investment- has plummeted too.

Investors have become ultra-wary of hi-tech hype, shifting their money away from this risky sector. Bad news, certainly, for anyone with promising ideas, no matter how revolutionary they appear. But in the eHealth sector, at least, firms are finding an unlikely savior. Pharma giants Eli Lilly and Merck & Co. have both launched their own venture capital funds to focus on healthcare eBusiness. Both companies want to use the Internet to speed up drug development and trials and to improve pharma, physician and patient relationships.

Merck was first on the scene. Its Merck Capital Ventures (MCV) unit opened for business in November 2000, to invest in emerging Internet healthcare firms. Although the company has been secretive about which firms it has invested in, it has $100 million to spend. Lilly has been more public about its $50 million e.Lilly fund, which was officially launched in January 2001.

Trials without tribulations

One of Lilly’s investments is in remote clinical trials specialist 1747. e.Lilly bought a minority stake in the company on April 18. The pharma giant will use 1747’s technology to speed up its R&D process, by enrolling patients in trials over the Internet and then collecting data from them more efficiently.

Lilly is very excited about the alliance, says 1747’s COO David Karshmer. They can reduce the cost of their trials, collect unfiltered data from patients (although obviously not including patient identities), and even build longer term connections with patients for future trials. Given that clinical trials are the most expensive aspect of drug development, taking up 28.3% of all R&D spending, it’s no wonder Lilly likes the idea.

e.Lilly has also invested in drug development informatics firm PharmQuest, which is creating an open standards-based platform for integrated development workflow, as well as specialized expert systems and knowledge bases for drug development. Its CEO Shankar Hemmady also extols the benefits of the funding scheme. This has indeed been a wonderful win-win partnership with Lilly.

Tailor-made for success?

But why should Lilly and Merck make these investments? Maryann Lombardo, an analyst at Datamonitor, explains that by investing in startups, the big pharma companies can make sure that promising products that meet their needs make it to market. Getting in early lets the pharma companies influence the smaller firms to focus on solutions that fit in with their own future plans. As Mr Hemmady says, the sooner pharma companies get on the bandwagon, the better off they will be down the road.

But the process has further benefits for the pharmaceutical funders. As a major shareholder in an eHealth research firm, a pharma company secures a better insight into the latest technological developments. The large companies should be able to ensure their own eBusiness and eResearch strategies are aligned with the technologies available for enabling their success, Ms Lombardo suggests.

Certainly, the pharma companies can benefit here. But it is not clear that these advantages are necessarily worth such large amounts of high-risk capital. After all, if a startup company is to have any sales at all, it must tailor its product to what the big healthcare firms want – whether they own shares in it or not. Equally, you don’t have to buy a company to find out information on its R&D.

And for that matter, there are tight limits on how close e.Lilly and MCV can get to the firms they invest in. We’re certainly not a division of Lilly, insists 1747’s Mr Karshmer, pointing out that Lilly does not get detailed information on everything his company is doing. Like a CRO, we need to maintain our clients’ – and patients’ – privacy.

The same is true for PharmQuest. Lilly’s position as a strategic investor gives them the opportunity to use our products along with other strategic pharma partners. Funds like e.Lilly are not looking for a quick return on their money. They are ensuring that their investments benefit the pharma industry at large. Any bottom-line gains made by speeding product development using PharmQuest’s products will far outweigh the gains made from the investments by e.Lilly and other strategic partners, says Mr Hemmady. His software firm has deals with two other major pharma firms, and is in negotiations with two CROs and three biotechs.

If nobody else is going to do it…

Given the relative independence of companies who receive venture capital, the competitive advantage from making the investment is less obvious. Another point, however, still tilts the balance in favor of investing. If startups lack the necessary cash to develop new solutions, then they may never advance beyond exciting concepts. And without new technologies, the giants will fail to hit their ambitious growth targets. A major R&D-based drug firm such as Eli Lilly expects to grow annually at 10-15 percent – by no means an easy task.

The same worry has driven similar investment decisions in other industries. Mobile communications market leader Nokia recently started its own VC fund to develop applications for its wireless phones. The company otherwise risked having handsets without functionality when they came to market.

The trend in the drug industry is best seen in the same light. Ms Lombardo sums up: The investments may ensure that Internet opportunities that could benefit the drug makers are not lost.

The pharma companies can also benefit directly from making their investments, more so than a conventional VC firm, according to Mr Karshmer. A big advantage of having Lilly as an investor is that they are also a customer. So they’re more interested in helping us overcome problems we face. They can give us the long-term strategic support that a VC firm couldn’t provide.

Part of this support comes in the form of the pharma companies’ expertise and industry experience. By providing the startup with healthcare-specific knowledge, the pharma company can actually increase the value of its investment. Mr Hemmady highlights his own experience. PharmQuest has benefited greatly by forming collaborations with major pharma companies, rather than developing our products in a vacuum.

A capital idea

In the current market climate, equity alliances between big healthcare firms and the startups seem an excellent idea. The advantages are just too great to ignore – and while there are financial risks, they are small compared with the potential gains.

Mr Hemmady isn’t the most neutral commentator, but it is hard to disagree when he says that the partnerships e.Lilly is building now should serve as a model for several future partnerships between eHealth companies and pharma companies. MCV and e.Lilly shouldn’t be the last of the pharma venture capital funds.