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Friday, June 29, 2007

Meet the Next Billionaires

Calling all geeks! Do you have a hot idea for a start-up? If so, this boot camp where Silicon Valley meets 'American Idol' is for you. That is, if you make the cut.

May 21, 2007 issue - Sitting at the long trestle tables in Y Combinator's Mountain View, Calif., headquarters last January, the Weeblies felt wobbly. Back home at Penn State, the three undergraduates were alpha geeks, go-getters who'd capitalized on the university's requirement that students have a Web portfolio by creating software that makes it really easy for students to build a personal site. The trio—David Rusenko, Dan Veltri and Chris Fanini, all 22 years old—decided to start a company, calling it Weebly because it sounded good and the domain name was open. Then last November they heard about a company called Y Combinator that gives seed money to fledgling start-ups and imports a bunch to Silicon Valley for three months of intensive entrepreneuring. They sent off their application the day before the deadline, and made the cut.

Now they were here, just down the road from Google and Yahoo, one of 12 companies that would be part of Y Combinator's winter program of total immersion in the Silicon Valley start-up life. For a techie, it was as if you were making home movies one day, and the next day found yourself on the Paramount lot with a contract and empty film cans to fill. No matter where the start-ups came from—Sweden, Chicago, Oxford or even the South Pole (yes, one person arrived straight from graduate research there)—their lives would never be the same. Also attending the dinner that night were veterans of the previous three Y Combinator programs—some of them millionaires before 25. You don't see too much of that in State College, Pa.

That's the charm of Y Combinator. It's "American Idol" meets Wired magazine. The inspiration came from Paul Graham, a high-energy 42-year-old who himself had a monumental start-up experience, selling his company Via-web, an e-commerce application, to Yahoo at the height of the boom, enriching himself and his buddies. In the spring of 2005 he made a speech at Harvard that was a broadband update of Horace Greeley ("Start up, young man!"), then realized that he could help make it happen for others. He gathered his former partners—Trevor Blackwell, now making robots, and Robert Morris, who achieved brief notoriety in the 1980s as the author of a virus that almost shut down the Internet—and recruited another friend, an investment banker named Jessica Livingston. They drew up the plans for an operation: from hundreds of applications, the YC partners would cull the 30 most promising, conducting "Idol"-style auditions to choose a dozen or so companies for the program. Each start-up is given $5,000 plus $5,000 per founder (a start-up with two founders would get $15,000). This money covers lodging, food and equipment during the program. In exchange, Y Combinator (named after a mathematical function) gets a piece of the start-up, usually 5 or 6 percent.

Some critics scoff that Y Combinator's investment is peanuts for that amount of equity. But the opportunity is unparalleled—total immersion into Silicon Valley start-up culture, advice from Graham and a fast track to the top angel investors and venture-capital funds. When Graham calls the winners, the founders have only five minutes to accept. "If people turn us down," he says, "as far as we're concerned they've failed an IQ test."

Every Tuesday during the program, Y Combinator hosts a dinner of chili or stew for the start-ups. At this first one, Graham and Livingston distribute gray T shirts emblazoned with one of Graham's pithiest admonitions, MAKE SOMETHING PEOPLE WANT. A second, black shirt is bestowed only to start-ups that achieve a "liquidity event"—a purchase by a larger company or an IPO. It reads, I MADE SOMETHING PEOPLE WANT.

Y Combinator's model dovetails perfectly with the new start-up ethic in Silicon Valley. It's dramatically cheaper to start a company now than it was in the dot-com boom, and possible to build a substantial operation before requiring venture capital or achieving that liquidity event. (To pay salaries and costs during that time, one can get "angel funding"—less money than a VC firm pays, but in exchange for less equity.) Software tools, which used to cost hundreds of thousands, are now largely free. A wide variety of tasks can be outsourced cheaply. Computers, servers, bandwidth and storage cost a fraction of what they did a decade ago. And there's no need for a marketing budget when you've got Internet word of mouth.

As a result, when it comes to funding, "$500,000 is the new $5 million," says tech investor Mike Maples. It's several weeks into the program, and Maples is in a Palo Alto, Calif., coffeehouse for a meeting with the Weeblies. He sees a lot of people barely out of their teens. The old wisdom for investors in start-ups said you needed an experienced hand as a CEO. The Valley's new wisdom: don't fund anyone over 30. The average age of Y Combinator founders is 25.

When the Weeblies show up for the meeting, they pull up Maples's Web site and, using their software, clone it almost instantly. Then they show him how he can use Weebly to tweak it easily and even redesign it. Maples's eyes open wide. Later he will explain that at that moment, he was determined to help fund the Weebly team.

Connections with top investors are common for Y Combinator start-ups. In May 2006, Condé Nast bought Reddit, a user-generated news site from YC's initial summer 2005 group. The amount wasn't announced, but Graham says the founders could live off it for the rest of their days—and they're only 23. "Before the Reddit sale there were questions about the Y Combinator model," says Mike Arrington, editor of TechCrunch, the unofficial racing form for Silicon Valley start-up news. Around the same time, another YC company also sold to a bigger one, but it wasn't publicly announced. Between the two sales, seven black T shirts were distributed. Others among YC's 38 companies so far have gotten hefty angel rounds and multimillion venture-capital deals.

By the middle of the winter session, tension is building for the start-ups, which are preparing for the upcoming Demo Day, when the room will be filled with investors. It is not uncommon for Y Combinator start-ups to hit the restart button and drastically change its approach as D-Day nears. One group originally planned to make online-based publishing software. After Graham's suggestions, it shifted the focus to collaborative word processing and changed the name of the company to WriteWith. Another start-up called Socialmoth set out to have people share personal secrets confidentially; the new idea was a place where people in corporations could anonymously post gripes and suggestions, allegedly leading to improved practices. (New name:

No company feels more under the gun than Zenter, formed by Wayne Crosby, 29, a former project manager living in Phoenix, and Robbie Walker, 23, a programmer in Texas. Last summer the two chums cast around for an idea for a start-up and decided to develop a totally Web-based PowerPoint-style application—it would be the Gmail of presentations.

Graham loves it when his little chicks take on the big birds. "These guys have written 40,000 lines of code in three months!" he crows. "You never see that in a big company!" The Zenters did it by living a spartan existence, sharing a threadbare apartment a five-minute walk from Y Combinator. This was especially tough for Crosby, who had left his pregnant wife behind in Arizona (the couple kept in touch by video Web chats). Their diet consisted of Lean Cuisine, with the exception of some frozen steaks that Crosby's father sent them. The Styrofoam box in which the steaks were shipped became their coffee table.

Looming over Zenter's efforts was the knowledge that Google was working on its own online-presentation app. The word, though, was that the Zenters' program was better, and one day Google invited them over. The search giant made an offer that Crosby and Walker considered too low, but didn't shut the door to further negotiations.

The Weeblies were also working with maniacal intensity. A Penn State alum who was a Y Combinator veteran set them up with an apartment in a North Beach high-rise that is so much a favorite of YC companies that its informal name is the "Yscraper." Paying $2,700 a month in rent for a two-bedroom unit with a spectacular bay view, the Weeblies pushed three desks together to make the dining area into office space.

On Demo Day, each start-up gives a 10-minute demo to a room packed with the top investors in the Valley. The Zenters lead off, using their own software to build the presentation for their demo online in real time; as they give it the Weeblies follow, and nail the crowd with the simplicity of their Web-site creation service. One of the biggest hits was a sleeper—Octopart, an e-commerce site created by two physics grad-school dropouts; it slickly aggregates the inventories of electronic-parts sellers (normally they are buried in phone-book-size catalogs) and makes them easy to buy. Some of the demos aren't as sharp, but none fall flat. "Angels and VCs who don't go to this are missing some of the best innovations," says Ron Conway, the Valley's most celebrated angel investor.

After Demo Day, there's only three weeks left, and the focus shifts from building products to getting funding to keep them going after the YC program ends in April. The Weeblies had buyout interest from a company in Maryland, Freewebs. Rusenko and Veltri took a red-eye to meet the Freewebs executives and, they say, received an offer in the low millions, two thirds of it in stock. They said no. Instead, they'd pursue the angel-funding offer sheet that was at their lawyers' office: Wilson Sonsini, the top firm in the Valley.

Pretty heady stuff for kids who were sitting out in the rain at football games only four months before. "It's almost as if I can't explain it to the people back home," says Chris Fanini. His partner Dave Rusenko agrees: "First you feel real green, then little by little the lifestyle becomes normal." Dan Veltri nods. "Yeah—then it's normal to turn down an offer in the millions."

The last Y Combinator dinner in the session, on March 27, was almost nostalgia-free—though things were over, they really weren't. Most of the companies planned to stay in the Valley. Y Combinator's Jessica Livingston now reports that all the companies in the group are still going strong—most have funding lined up and the others have good prospects for money to keep them going until they build an audience. One has even tentatively agreed to a multimillion-dollar buyout from a major tech company. (Since no deal is a deal until the final papers are lawyered and inked, secrecy is paramount.) "We're going to have to print more black shirts," Livingston says.

And the Weeblies? They completed their angel round—$650,000, with the money coming from a consortium that includes Conway, Maples and Paul Buchheit, the former Googler who wrote Gmail. What did they do to celebrate? "We had a beer or two and then we went back to work," says Rusenko. This month they're returning to State College—to graduate with their class as Silicon Valley heroes.

By Steven Levy
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