After leaving Yahoo, Graham spent most of his time writing essays about technology and business and developing a new programming language. His best work was collected in a book, published in 2004, called Hackers and Painters: Big Ideas From the Computer Age. “Everything around us is turning into computers,” he writes in the preface. “So if you want to understand where we are, and where we’re going, it will help if you understand what’s going on inside the heads of hackers.”
In March 2005, Graham was invited by the Harvard Computer Society, an undergraduate group, to talk about starting a company. “I told them to raise money from angel investors, preferably people who have started start-ups themselves,” he says. After delivering that line, he glanced at the audience and noticed that everyone was looking at him expectantly. Fearing a deluge of bad business plans from bright-eyed Harvard students, he quickly added, “Not me.” Later that day, while having coffee with some of the students, he remembered that if he hadn’t been able to find his own angel investors, Viaweb never would have gotten off the ground. He decided it might be worth seeing what these kids could come up with.
Y Combinator began as an experiment in angel investing, conducted during the summer of 2005. Graham recruited Morris, Livingston, and a Viaweb employee named Trevor Blackwell to join him. The pitch was straightforward: $6,000 for a company with one founder, $12,000 if the company had two founders, and $18,000 if the company had three. In exchange, Y Combinator would get roughly 6 percent in common stock. (Exact ownership stakes vary. The most Y Combinator has taken is 10 percent; the least is 1.4 percent.)
Graham promoted the program with an essay that he posted on his website and that quickly found its way to many college students’ e-mail inboxes. “We give you enough money to live on for a summer, as with a regular summer job,” he wrote. “But instead of working for an existing company, you’ll be working for your own; instead of showing up at some office building at 9 a.m., you can work when and where you like; and instead of salary, the money you get will be seed funding.”
Graham received 227 applications, mostly from computer science students, and he invested in eight start-ups. Half went on to raise additional funding, and two turned down acquisition offers. Graham knew that most of the companies would probably die, but he also believed he was onto something. For example, Loopt, which develops software for cell phones that allows users to see where their friends are, managed to raise $13 million from two Sand Hill Road firms. Another company in the first batch, Reddit, operates a social news website similar to Digg. It was acquired by Condé Nast just a year and a half after its founding and before it had hired any full-time employees. Though the price was not disclosed, reports have pegged it at anywhere from $10 million to $13 million, which means that Y Combinator generated a sizable return, as much as 25 times its initial investment.
Reddit is a good example of what happens to a Y Combinator company when most things go right. But few Y Combinator start-ups enjoy such a straight line to success. That, in part, explains why Graham encourages companies to release products quickly. Doing so, he says, is the best way to turn a bad idea into a good one. “As long as you pay attention to your users, you can change a bad idea,” he says.
Case in point: Justin.tv. The wildly popular online video site now attracts 41 million viewers a month. But it has its roots in a failed start-up called Kiko. The company, a part of Y Combinator’s first class, began with a plan to do for online calendars what Google’s Gmail had done for e-mail. Things went well at first, but then Google decided to do for calendars what it had done for e-mail, making Kiko suddenly irrelevant. Co-founders Justin Kan and Emmett Shear bailed out and sold the company on eBay for $258,000.
Graham lost money on the idea but nonetheless decided to back Kan and Shear’s next venture, a bizarre take on reality television. Kan attached a video camera to his head, wore a backpack stuffed with cell-phone modems, and broadcast his life 24 hours a day. The idea was that Justin.tv would produce similar programs and sell equipment to aspiring reality stars. “I thought it was insanely weird,” Graham recalls.
Kan’s life attracted a few thousand fans and reams of press. But Kan soon noticed that instead of broadcasting from hat-cams, some users were interested in more traditional types of broadcasting. “People were e-mailing us saying, ‘I want to broadcast a bike race or a talk show or a concert,’ ” Kan says. “We were like, ‘OK.’ ” Kan stopped wearing the camera and focused on building a live video platform.
This kind of meandering path, Graham says, is encouraged at Y Combinator. “A lot of great companies started with different ideas,” Graham says, noting that Steve Jobs’s first plan for Apple was to sell do-it-yourself plans for building computers. “You need to listen to your users, figure out what they want, and do that.” When founders are accepted into Y Combinator, they are given a gray T-shirt that says, “Make something people want.” When a company sells, the founders get a black shirt that says, “I made something people want.”