Sunday, August 9, 2009

Companies Tony Loves: Y Combinator

Imagine you have an idea for a new program that will revolutionize the way people use the Internet, but you have no experience with running a business. Your idea is a great one, but you have no money and no connections. Without some financial assistance and some good advice, your idea is doomed.

Now, let's switch it up: imagine that you're a manager at a venture capital (VC) firm. You're looking for a company that is both very likely to do well and in need of some start up funds. By financing this company through some of its initial stages of development, your VC firm can buy a large stake in a successful business.

Naturally, one would think that the idea holder in the first paragraph is the perfect fit for the VC firm in the second paragraph. Provided that the idea is a good one, the firm should be happy to finance the young innovator to help bring that idea to fruition. Why not bring the two together?

There's just one problem. A good idea does not make a company. A good idea does not automatically bestow credibility. In short, a good idea is not enough. Without a credible track record, the person with the idea is going to have a hard time convincing the VC firm to invest. With no investment, the idea dies, and the innovator does something less innovative.

Enter this week's company I love, Y Combinator (YC). I heard about YC on last week's EconTalk podcast, where Russ Roberts interviewed Paul Graham, one of the partners in Y Combinator. It's a fascinating podcast, worth a listen. Among other things, the podcast convinced me that the world is a better place because of Y Combinator.

So what does Y Combinator do?
YC is a new kind of venture firm. Instead of taking on companies that are already companies and bestowing boatloads of money upon their likely success, YC takes on innovators who have ideas. Because they enter earlier in the process, their anticipated success rate is much smaller than a VC firm, but as the story of the dead idea above illustrates, YC can do some real good by helping an idea become VC-worthy.

In doing so, YC get to take their cut, but they also help innovators be innovative. From your perspective at home, you get to enjoy more cool stuff because YC helps bring it into existence. Now, that's a reason to give them love.

So, what's so special about Y Combinator?
Not only does YC provide seed funding for these innovators to turn their ideas into a business, but YC trains the innovators in the art of entrepeneurship. Their monetary investment is much smaller than a VC firm, but their time investment is substantial. YC works with startups, giving them advice on their innovations and hosting dinners with established entrepeneurs.

In the process, they empower innovators with good advice. Cheering on innovation is YC's comparative advantage. Innovation is a difficult and discouraging thing to do. It's hard work, and because it is something new, there are many disbelievers. In a world where too many people ask why, Y Combinator encourages new ideas with the simple question: why not?

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Notes and links:
1. To be fair, Y Combinator asks a lot of other questions than "why not?" They're careful about investing, but they also recognize that they're in a business where they take a lot of risk. And, more importantly, they see a particular type of risk that other firms are not taking, so they take it. Here's an interesting fireside chat with Paul Graham (one of the partners in Y Combinator) and a representative from a competing firm Sequoia.

2. Here's a link to the Y Combinator application form, including what they look for in a startup.

3. In the Y Combinator FAQ, there's a nice summary of the firms they've financed. Among them? Reddit, Scribd and Justin.TV

4. Paul Graham is a fascinating person, and a great advocate for Y Combinator. See his podcast on EconTalk, and a list of his essays. He has an interesting perspective on life.

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