Y Combinator Inspires Imitators

Y Combinator Inspires Imitators

September 26, 2007, 11:13AM EST

Paul Graham’s intensive workshop permits investors and startups to
check each other out with a minimum of risk and a maximum of potential

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Y Combinator’s Paul Graham with two cofounders of Octopart, a vertical search engine for electronic components.

Paul Graham knows that most startups will eventually fail. But at Y Combinator,
the hacker guru’s seed fund for young techies, they’re encouraged to
fail fast and fail cheap—and then to reboot and start again. Designed
with the new economics of Web-based entrepreneurship in mind, Y
Combinator is a new type of venture fund—dispensing tiny amounts of
cash but lots of hands-on mentoring.

Since its founding in 2005, Y Combinator has funded 58
startups—nearly all in software or Web services—bringing in a new crop
twice a year (in Cambridge, Mass., in the summer; in the San Francisco
Bay Area in the winter) for a three-month crash course in the Graham-ian philosophy of entrepreneurship
(BusinessWeek, 9/26/07). Each team gets a small sum to cover basic
expenses ($5,000, plus $5,000 per founder) and the chance to pitch
their idea to a roomful of top angel investors and venture capitalists.
The insider status of Graham himself—a Web software pioneer who sold
his startup to Yahoo! (YHOO) in 1999 for $49 million—lends additional cachet.

"Cheaper Equity"

In return, Graham and his four partners get a stake in the company,
usually about 6%. So far, Y Combinator investments like the social news
site Reddit, acquired by Condé Nast in 2006, and slide show app-maker Zenter, acquired by Google (GOOG)
earlier this summer, both for undisclosed amounts, are positive signs
that the formula works. Because the sums Y Combinator invests are so
small, even early-stage acquisitions can translate into relatively big
paydays.

After two years, Y Combinator’s portfolio is still too young to
fully evaluate the success of Graham’s strategy—but that hasn’t
discouraged a growing number of investors around the globe from
launching their own copycat programs.

One main reason? "It’s cheaper equity," says David Cohen, the
executive director of the most established Y Combinator counterpart, a
Boulder (Colo.) program called TechStars, which ran its first
three-month session in May, 2007. "If you look at the companies that
are getting to an A-round, the model that we’ve created gives a
significant discount to those valuations." Critics say that makes the
arrangement exploitative for the startups involved, but Cohen
disagrees: "I think for a first-time entrepreneur, it’s actually an
incredible deal."

Both Cohen and Graham say money is actually among the least
important things they offer to entrepreneurs, since drastically cheaper
hardware, software, and bandwidth—among other factors—have made it much easier to start a company than it was a decade ago (BusinessWeek, 5/31/07).

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The weekly dinners Y Combinator hosts are a welcome respite for many of the program’s participants.

Dating Before Marriage

But disappearing barriers to entry also make it harder for any one
startup to stand out in the crowd—a challenge that’s as tricky for
investors as it is for entrepreneurs themselves. Without a track record
to go on, after all, how do you discern a future Mark Zuckerberg (Facebook) or Kevin Rose (Digg)
from a sea of equally fresh-faced, Red Bull-swilling computer whizzes?
With a program like Y Combinator, investors get three months of
hands-on experience with talented entrepreneurs—and an early look at
their work—before reaching for their checkbooks.

Cohen says he’s already fielded inquiries from angel investors in
20-odd cities, all interested in starting similar programs of their
own. "You’re going to see a massive proliferation of this model," he
predicts.

Graham, a widely read essayist who has written prolifically on
topics like "What Business Can Learn From Open Source," isn’t flattered
by the unauthorized open-sourcing of his own model—including one clone
in Vienna shamelessly named YEurope. (His opinion about such copycats
is made clear on Y Combinator’s FAQ. Question: "Will you help us set up
something like Y Combinator in our town?" The answer: "There already is
a Y Combinator in your town: Y Combinator.")

Why Reinvent the Wheel?

Many of Graham’s admirers, however, say they respectfully disagree. Among them is Web industry veteran Saul Klein (BusinessWeek, 6/7/07), a partner at London venture capital firm Index Ventures and a former executive at Skype (EBAY).
Klein helms the most prominent Y Combinator lookalike in Europe thus
far: the London-based Seedcamp, which launched in September. In a
slightly novel twist, Seedcamp began its competition by bringing 20
startups—plucked from an application pool of 268—for an "unconference"
(BusinessWeek, 5/14/07) before selecting six companies to participate
in the three-month program. Each of the six companies received €50,000
(about $70,614) in seed money—a considerably heftier sum than other Y
Combinator-like programs—with Seedcamp taking a larger, 10%, stake in
each.

And bona fide venture hubs like London aren’t the only place the Y
Combinator model is attracting interest. Cities such as Lexington, Ky.,
and Milwaukee are taking note, too. In Atlanta, a small group of angel
investors hopes to replicate the Y Combinator model with a program
called BoostPhase. Co-founder Wayt King says he envisions BoostPhase,
set to launch this fall, as "a Y Combinator for the Southeast."

"We have huge respect for Paul Graham and what he’s done, and we
figured there’s not much sense in reinventing the wheel," King
says—adding that he doesn’t see BoostPhase as competition for Graham’s
original. "There are a lot of entrepreneurs who don’t want to or simply
can’t move to Silicon Valley or Boston."

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The cofounders of Fauxto make their pitch to investors at a Y Combinator demo day. Jessica Livingston

Standing Out from the Crowd

TechStars’ Cohen says he’s not worried about the competition.
"There’s a pretty clear demand for this," Cohen says, noting that the
10 startups TechStars funded represented only 26 of 302 applicants. Y
Combinator accepted an even smaller number for its summer 2007 round—19
of 435 applicants—making an applicant’s chances of getting tapped for Y
Combinator (4.4%) only slightly higher than those of the brainiacs
vying for a Rhodes scholarship (last year’s acceptance rate: 3.6%).

For participants, the real draw of a program like Y Combinator isn’t
the money, it’s credibility—and not just with investors. The traffic
bump from an early mention about getting funded on an influential blog
like TechCrunch can be just as crucial as a Series-A round in helping a
Web startup gain traction over its rivals. And by adding structure to
an otherwise nebulous pursuit, Y Combinator also makes a startup a less
risky endeavor for entrepreneurs themselves—both practically and
psychologically. "Y Combinator provided a socially acceptable way to
drop out or postpone my college education and focus on the company
full-time," says Kevin Fischer, a 21-year-old industrial engineering
student at the University of Pittsburgh who applied to both Y
Combinator and TechStars. Plus, he adds, "It seems like even the people
that fail still go on to jobs at Google—no one does too badly."

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