Am I missing something or are there only really the extremes when it comes to functionality. Is there nothing in the middle that uses e-paper displays with some form of note taking capability?
The iLiad is the best for this, but you may also want to look at the eBookwise 1150, which uses an LCD screen but does offer stylus note-taking ability.
You don't really have to get into the hardware business, though, particularly if you go with a widely supported format (see below).
What format would everybody recommend for me to investigate further? please bear in mind that some form of DRM has to be supported and please try not to turn this into a discussion on DRM
If you insist on DRM, Mobipocket is probably your best bet. It is supported on the widest range of systems, including the iLiad, desktops and notebooks, Cybook, etc. Bear in mind that any DRM can be broken and the protection being offered is somewhat illusory, and that DRM will add to your costs. I know you don't want to make this a DRM discussion but there are aspects that particularly relate to your needs that are probably worth considering.
Would I be better going for a proprietry format for our educational titles and developing a reader for that format for the Iliad and selling e-books and reader into the educational sector as a package and then going with a more generic format for our trade list?
Please DO NOT develop another proprietary format. You will not help anyone by doing that. Take a look at the ePub standard (which will be supported by Mobipocket in the future and probably other vendors as well). Go with the most generic format possible for all your products. You will avoid limiting your return on investment this way.
Also, take a look at the DotReader project (http://dotreader.com
). For your educational titles, you may want to consider offering DotReader server functionality as a tie-in.