Y Combinator: The Harvard Of Silicon Valley

Last week, 60 companies began a three month startup boot camp at Silicon Valley's Y Combinator. If all goes well, they should be worth millions by the end of the summer.

As the country faces continued economic stagnation and flirts with breaching the debt limit, investors have seemingly hunkered down, lending little outside the most established, credit-worthy circles.

In this evironment, one might think America's days of risk-taking are over -- at least in the near term. But even in today's chilly climate, Y Combinator provides a prime example of how capital warms to early stage companies that present a good deal of risk, provided they can demonstrate a claim on cutting edge innovation. For better or worse, Y Combinator's success in identifying productive, profitable companies might help shape the next iteration of the American economy.

Dubbed “the most prestigious program for budding engineers" by Wired magazine, YC (as it is known in Valley parlance) has become the gold standard for business incubation.

The six-year-old company is the brainchild of Paul Graham, a highly regarded essayist, web developer and renaissance man. Graham has an AB from Cornell, a Ph.D. in Computer Science from Harvard, and studied painting at RISD and the Accademia di Belle Arti in Florence.

Named for a mathematical function, Y Combinator had rather humble beginnings. In 2005, following a speech at Harvard entitled “How to Start a Startup” Graham secured funding for a pioneering program that would give seed money, usually less than $20,000, to startup businesses and offer guidance and connections as part of a three-month workshop series.

Now, as evidence of how prestigious YC has become, Russian billionaire investor Yuri Milner, in partnership with angel investor Ron Conway and his SV Fund, earlier this year announced they would give $150,000 in convertible debt to every business graduating from the YC program. These represent some of the most startup-friendly terms possible, according to industry analysts.

Given his early investments in companies like Facebook, Zynga and Groupon, Milner's seal of approval on Y Combinator has increased the hype that now surrounds each Demo Day, the end of the term when founders present their business models to investors. Some in the industry credit YC with fomenting a frothy tech market, where investors face stiff competition to support the Valley’s latest and greatest.

Inevitably, this has led to a backlash. During last year's “Angelgate," Valley superinvestors discussed Y Combinator’s seemingly disproportionate power and how to combat the competition it has created among investors.

YC's success has also spawned a fair share of imitators. A Wall Street Journal article last month detailed similar incubators and the investors who love them.

But YC remains the standard. Its numbers would seem to prove the point: In a recent blog post, Paul Graham estimated that the average value of a Y Combinator company is $22.4 million. As an indicator of "success," Graham looked at how many companies raised funds after going through YC. The success rate? Ninety four percent.

Those who enter the bootcamp, an intense series of workshops, lectures, brainstorming and strategy sessions conducted while participants launch and run their own startups, range from college dropouts to finance gurus ready to make a change. While YC's admission rate has stayed fairly level, hovering around 2.5-3 percent, the class size has increased. Last week, YC convened its largest group to date, with 60 entrepreneurs.

Harj Taggar, a YC alum who now serves as a partner at the company, acknowledged that when he participated in 2007, “It was nothing close to the competition it is now. But in terms of the percentage that is accepted, the chances remain the same.” Taggar said that when applicants are brought in for interviews, no attention is paid to how many have already been accepted. “We keep a thesis: if someone is good enough to fund, then we fund them.”

In trying to decode what, exactly, it is that makes Y Combinator so successful, most of its participants cite its mantra: “Make something people want.” Graham and his team believe so strongly in this proposition that they encourage founders to abandon their ideas early and often in pursuit of finding something useful.

“When we joined YC, we had an event recommendation idea,” said Helen Belogolova of Venuetastic, an online network that connects venues with people looking for event space. “There's all this information out there on Facebook about people's interests and hobbies. And we thought, what if there was a great way to focus on these interests and connect the people who shared them?”

Belogolova explained that after gaining entrance to YC, “PG definitely urged us not to do it. He said people were lazy, and wouldn’t use [the service]. But we were stubborn.” After several weeks of testing, she said, “we came to our own conclusion -- the one that PG had come to automatically. People want to hear and know about events, but it’s a very passive interest.”

When Belogolova & Co. finally came up with the idea for Venuetastic, she recounted that “PG was cautious, but he said, Go try it, come back with proof -- proof that we were building something people needed and something people wanted.” Belogolova concluded, “If we hadn’t gone through that process, wouldn’t have come up with Venuetastic.”

The other fundamental, which follows from its mantra, is that YC chooses people, not necessarily business models.

“During my interview, Paul said, ‘Look ,what you have now is crappy -- but we like you,” said Daniel Gross, founder of Greplin, a search engine for personal files. Gross abandoned his initial business model, came up with a list of “20 others” and went to Graham seeking advice. When he pitched the idea for Greplin, Graham said, “That it seemed the most interesting. It feels like a problem that you’re personally having.”

“It’s very rare to see a product succeed if it didn’t come out of an actual need of the entrepreneur who created it," Gross acknowledged.

Darshan Shankar, the founder of Nowjs, a web infrastructure company, recounted that he joined YC as a 19-year-old UC Berkeley dropout. Shankar and his partners had developed an online shopping interface that had found some significant interest from investors right before they entered YC.

But, he recalled, “Paul was first person to question why we were working on shopping. He asked us why we were passionate about it.” Shankar and his partners, passionate about hacking more than anything else, “realized that while our product was interesting and the interface was cool, at the end of day, we didn’t really care about shopping. It was such a crucial question.”

Both Shankar and Gross exemplify a certain YC strategy: namely, bet on talented people to develop things they find personally useful. By Graham’s count, 94 percent of the time, the business will be a success.

Taggar explained that in addition to advice, guidance and strategy, YC also plays matchmaker between businesses and investors. “When YC companies need access to companies who wouldn’t otherwise talk to them, we help make deals. With Facebook, for example, YC startups get priority support,” he added.

All of which is decidedly useful, but perhaps, not what makes YC singular. Much like a top-tier university or a really great music producer, YC offers its startups a wholly supportive environment where they are encouraged to experiment, fail and, ultimately, innovate.

Though the sessions last only three months, and founders spend much of that time furiously at work on their businesses, YC participants all reiterated the closeness of their networks. “If I get an email from someone from YC, I’ll usually send a response within 24 hours,” said Ian Hogarth, the CEO of Songkick, a ticketing and information service.

“Y Combinator introduced me to my co-founder,” said Greplin’s Gross. “For what it’s worth, their network was effectively able to create this company.”

While YC can take credit for producing fruitful unions, Taggar underscored its role as a facilitator, finding those who might otherwise languish in the engineering department, and creating an environment where they can succeed as entrepreneurs.

“There's this idea of the 'born' founder," he said. "The truth is, founders -- even Steve Jobs hesitated as to whether he should have committed to Apple. Sergey [Brin] and Larry [Page] -- they could easily have remained in academia."

As Y Combinator would have it, the good ideas are out there. It's just a matter of helping people realize that they've had them all along.