Lilly reorganizes venture capital unit

Eli Lilly and Co. has reorganized its venture capital division and simultaneously poured in an additional $25 million.

Now that Lilly Ventures is an autonomous subsidiary of the drug giant, it will be able to pay its managers more
when their investment decisions generate spectacular returns. The unit’s six employees previously couldn’t take
a cut of profit because of restrictions in Lilly’s compensation policies.

“For us, it came down to
ensuring we continue the success we have had by continuing to attract and retain high-quality talent,” said Darren Carroll,
Eli Lilly’s vice president of new ventures.

Formed in 2001 with $175 million, Lilly Ventures is Indiana’s
second-largest venture capital firm. Eli Lilly has been and remains its sole investor. Lilly Ventures will continue to report
up through the drugmaker’s chain of command, but with greater independence.

Carroll

Lilly Ventures’
money so far has gone to nearly two dozen biotech, medical technology and health care IT startups around the world, none based
within Indiana. Outlays from its original fund, now fully invested, have generally ranged from $1 million to $5 million.

Carroll declined to detail the fund’s previous financial performance or share its returns. But he pointed
out that several of its investments have achieved clear success. For example, after an early investment from Lilly Ventures,
Durham, N.C.-based lung cancer drugmaker Serenex Inc. was acquired by New York-based Pfizer Inc. for undisclosed terms.

Two more Lilly Ventures portfolio companies have staged initial public offerings. Waltham, Mass.-based drug trial
safety data monitoring firm Phase Forward Inc. raised $35 million in a 2004 IPO. And Palo Alto, Calif.-based drug developer
XenoPort Inc. had a $49 million IPO in 2005.

Long-term potential

Venture firms
typically strike out with some investments but hit home runs with others. Lately, the industry hasn’t been immune to
the global economic downturn. The average one-year return for all U.S. venture firms in 2008 was a negative 20.9 percent,
according to the Arlington, Va.-based National Venture Capital Association.

But in the long run, Carroll and
his partners now have the opportunity to earn hefty paydays. The average annualized 10-year return for U.S. venture funds
was 15.5 percent. For early-stage investments like those Lilly Ventures makes, it was a whopping 36 percent.

Carroll said Lilly Ventures will use part of the $200 million infusion for follow-on investments in the other startups still
in its portfolio. The rest will fund speculation on new ventures. Outsized financial returns are the top goal. But a secondary
priority is for investments that fit strategically with Eli Lilly.

A good example of that concept is Philadelphia-based
Avid Radiopharmaceuticals, Carroll said. Lilly Ventures is an investor in the firm, which he said is a pioneer in molecular
brain imaging. Avid has developed targeting agents that are being clinically tested for use in detecting Alzheimer’s
disease. Carroll said Avid has used the same technology for testing Eli Lilly phase three compounds.

Exposure
to breakthroughs

Eli Lilly’s top management understood from the start that a sizable venture capital
fund would expose the parent company to cutting-edge research and technology around the world, said Chuck Schalliol, who helped
organize Lilly Ventures as well as BioCrossroads’ $73 million Indiana Future Fund before he went on to become Gov. Mitch
Daniels’ first state budget director.

Schalliol, now a Baker and Daniels LLP partner, said John Lechleiter,
Eli Lilly’s current CEO, was an early champion.

They knew Lilly Ventures occasionally might help identify
compounds Eli Lilly eventually could bring to market, Schalliol said. But more often, it would help develop the tools, devices
and collaborative laboratory relationships that ultimately lead to drug discovery. And most important, Lilly Ventures had
the potential to make a lot of money for its parent.

He said the drugmaker’s
army of scientists serves as an invaluable sounding board when Lilly Ventures managers evaluate investment
opportunities.

“I used to say we had the largest scientific advisory board in the
business, with 3,000 scientists whose day job is inventing drugs,” Schalliol said. “Lilly
has the blessing of being able to draw on this rich, deep scientific pool to validate deep scientific
questions that mere businessmen and -women couldn’t evaluate on their own.”

Schalliol added, “As
someone who put a lot of sweat equity into it, I’m just glad it went well.”

Corporate funds closely
affiliated with a single large company aren’t uncommon in the venture capital industry, noted John S. Taylor, research
director for the venture capital association. Neither are moves to distance the funds from their parents. Giants like General
Electric and Bank of America have successfully separated their venture operations.

A measure of independence
is important for corporate venture funds because most venture deals also include other outside investors.

Taylor
said “institutional” VCs—who usually raise their own funds from dozens of large pensions, university endowments
and corporations—often question whether corporate funds’ loyalty is to their deals, or their parents.

And as life sciences investing becomes increasingly expensive, forming investment syndicates is more important than ever.

“$100 million in the life sciences doesn’t go as far as it used to,” Taylor said.

Ironically, the deep recession may make this an opportune time for Lilly Ventures to launch a new round of investments. The
aging U.S. population is creating opportunities for health care firms, Taylor said. Meanwhile, the backdrop of federal health
care reform means change is on the horizon. And the economic downturn provides a wealth of bargains.

“Bottom
line, history has shown, with the goal of venture capital being buy low and sell high, there are very few points in time that
were simultaneously good for both,” Taylor said. “This right now in the minds of many people is a very, very good
time to be buying low.”

Schalliol praised his former employer for its commitment to Lilly Ventures. Historically,
he said, many large companies have dabbled in venture capital. But most give up after just a year or two when returns aren’t
quickly realized and management loses interest.

“It really does require patient and thoughtful management,”
Schalliol said. “Lilly provided that for us.”•