When Paul Graham started Y Combinator in 2005, I wonder if his business plan looked like what Y Combinator has become today. Since he says he doesn’t care about business plans for companies that are part of Y Combinator, perhaps he didn’t have one. Nevertheless Y Combinator is a very successful catalyst for companies like Xobni, Scribd, Justin.tv and Reddit. For a quick overview of Paul Graham and Y Combinator read last month’s Inc Magazine article.
In my opinion, Y Combinator is a brilliant concept for entrepreneurs, but perhaps even more so for the investors. For young entrepreneurs, they become immersed in what one observer called an entrepreneurial “cult”. The average age of a Y Combinator company founder is 25, and one of the most important contributions that Y Combinator makes beyond a dollar investment is mentorship. Startup companies typically get $5,000 plus $5,000 per founder (2-4 person companies). The founders get a crash course in starting a company and must develop a software prototype in three months. Y Combinator takes an average 6% stake in stock in the company. To date, Paul Graham has funded over 145 companies using this model.
For investors, even though it is early from a VC perspective, this model should prove wildly successful. For easy math, let’s assume 100 companies funded at an average of $20,000 each – a $2 million investment. Let’s also assume that just one of those companies gets acquired for the modest amount that Paul Graham’s company Viaweb was acquired for in 1998 by Yahoo – $49 million. 6% of $49 million is $2.9M. So if just one company gets acquired, Y Combinator could make almost a 50% return on a $2M investment. Not bad.
But of course, Mr. Graham expects more than one company to be acquired or go public. To date, Reddit has been acquired for $12.8M, Google acquired Omnisio for reportedly $15M, and Cisco acquired Zenter for an undisclosed sum. Many other Y Combinator companies have gone on to receive further funding from leading VC firms. No home runs yet, but in terms of venture capital investments, it’s still early. Most VC funded companies don’t see an exit for 5-10 years.
For someone that doesn’t care about business plans, Paul Graham seems to have hit a home run with his business model. Another few years should confirm it.
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