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Some prominent venture capitalists are betting that the Internet strategies that created giants such as eBay and PayPal could reshape the ailing U.S. health-care system. That system currently devours 18 percent of the world’s largest GDP while delivering mediocre health results.

In August, the online health marketplace ZocDoc, which lets patients look up doctors by specialty and zip code and make appointments over the Internet, raised $50 million from the investment fund of Russian billionaire Yuri Milner, who in the past has backed companies like Facebook, Twitter, and Groupon.

The idea behind ZocDoc and other startups getting funding is that our costly, paper-based health-care system is ripe for the same technological fixes—such as data visualization, cloud computing, and mass-market self-service concepts—that have transformed industries such as consumer banking and travel.

However, many venture investors say that investing in health-care IT (HIT) isn’t as easy as putting money behind, say, the latest social-media company. Health care is more complicated, more regionalized, and subject to more government rules. The U.S. Food and Drug Administration surprised many software entrepreneurs this summer when it said it planned to regulate some health software apps for phones.

“A lot of venture capitalists say they are investing in HIT, but right now, there seems to be more education going on than investing,” says Rebecca Lynn, a partner at Morgenthaler Ventures, based in Menlo Park, California. 

According to Dow Jones VentureSource, venture investments in HIT rose about 20 percent in 2010, to $460 million, or about a fifth of the $2.3 billion that venture capitalists invested in all health companies, including biotech firms.

Jessica Canning, research director for VentureSource, says half the deals counted in 2010 were seed-stage or first-round financings. That is “very promising at a time when VCs are struggling to keep their existing portfolios alive,” she says. “It means a pipeline is being built in HIT.”

Even so, many entrepreneurs are running into difficulty finding investors who understand both the heavily regulated health-care industry and software innovation, says Sonny Vu, cofounder of Agamatrix, which manufactures a diabetes monitor for the iPhone. “On the one hand, you have people raising money who know nothing about regulation or reimbursement codes; on the other, a bunch of health-care guys who think Zynga is some kind of fruit. There is truly a chasm between world views.”

Some investors also question whether the venture capital model of plowing money into risky early-stage companies will pay off in HIT. “Relatively few VCs have sufficient depth of expertise with both the health system and IT,” says Barbara Lubash, a managing director at Versant Ventures, also in Menlo Park. “But the usual reason HIT doesn’t get funded is because the opportunities aren’t large enough.”

One reason is that most large hospitals have already sunk hundreds of millions of dollars into legacy IT systems built in-house or developed by dominant players such as Siemens, or Midwestern companies like Cerner or Epic, and are unlikely to move to new offerings. As a result, many entrepreneurs are looking for underserved niches in HIT, such as health apps meant to run on mobile devices. But those kind of inventions have limited appeal for professional investors, says Lubash: “We look for opportunities that are reasonably large, capital-efficient to pursue, and positioned to achieve sustainable competitive advantage. There aren’t a lot of those models in HIT.”

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Tagged: Business, Business Impact, The Era of E-Medicine

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