"I'm probably the only person hoping the recession wouldn't end."

With this one sentence, Paul Graham captures the opportunistic spirit and fearless ambition emanating from his unique, "don't call us an incubator" venture capital creation, called Y Combinator (YC). While not widely known, YC is growing a cult-like following among young programmers looking for a stepping stone on their path to conquering the world.

Who, What, Y Combinator?
Y Combinator founder Paul Graham is best known for selling Viaweb to Yahoo! (NASDAQ:YHOO) back in 1998 for about $49 million. Viaweb subsequently became the backbone of Yahoo! Stores.

In 2005, Graham launched YC as an experimental bootcamp for talented and ambitious hackers. It has since grown into an organized, semiannual program that provides participants with weeks of in-depth mentorship as they develop their startup. The program culminates with a final unveiling to a select group of investors at "Demo Day." YC also offers seed funding, usually doling out $5,000 per team member in addition to $5,000 per company formed. In return, YC receives a 2%-10% equity stake in the venture. This may seem like a paltry sum, but the goal is to provide just enough "bread" for the teams to get their ideas up and running without ruining their competitive appetites.

Y Combinator finds itself aiding, abetting, and nurturing a clever crop of Web startups that are siphoning off the competitive moats of the Nasdaq 100 while simultaneously striking deals with them. In their relatively short lives, YC alumni have made some impressive strides:

  • Loopt (2005), a mobile social networking company, has found its way onto all the major U.S. carrier networks, including AT&T (NYSE:T), Verizon (NYSE:VZ), and Sprint Nextel. In addition, the company snagged an impressive advertising agreement with CBS last year.
  • Scribd (2006), a Web-based document publisher, has partnered with literary heavyweights Random House and Simon & Schuster to distribute content on its platform. Scribd has also raised over $12 million in venture funding.
  • Xobni (2006), an e-mail software maker, was demoed by Bill Gates at Microsoft's (NASDAQ:MSFT) Developer Conference in early 2008 -- an event which led to speculation of a $20 million buyout offer. Rejecting the alleged offer, Xobni has reportedly received nearly $15 million in venture funding.
  • Weebly (2007), a website authoring toolmaker, is one of several "freemium" models that may have contributed to Yahoo!'s recent decision to close its Geocities service, which Yahoo! spent $4.5 billion to acquire in 1999. Great news for a tiny company that recently hit the 1-million-users mark and is both profitable and growing.
  • Omnisio (2008), an online video annotator, was acquired last year by Google (NASDAQ:GOOG) for a undisclosed sum that was speculated to be around $15 million.

Amazingly, this is only a taste of the successes reaped by the four-year-old venture firm.

Killing monopolies $5,000 at a time
Armed with a growing track record, Y Combinator has its sights on capturing some of the biggest market opportunities out there. In his article "Startup Ideas We'd Like to Fund," Graham lays out a clear hit list of monopolies that he believes can be competitively busted. If the right entrepreneurs successfully heed his ideas, there are at least half a dozen Fortune 500 companies that could see their moats penetrated and profits decimated.

For example, Graham believes that because eBay (NASDAQ:EBAY) has ignored its auction service, the space is ripe for innovation. Graham also thinks that Web-based companies that nibble off segments of Microsoft's Office monopoly have promise. Graham points out that Intuit (NASDAQ:INTU) is susceptible to being overtaken in the individual and small-business market by simpler, localized applications. Graham clearly wants to drink some big-cap milkshakes.

Y's wide shut
If imitations portend success, prospects for Y Combinator appear bright. The rash of imitators such as Yeurope, Techstars, and Launchbox doesn't seem to faze the YC founders. The fact is, the YC moat grows with each graduating class. YC's growing alumni network and affiliated "Hacker News" message board simply serve to strengthen their competitive advantage.

The YC team is as interested in accessing angel investors as they are in funding entrepreneurs. They recently hosted the Angel Conference specifically to stir up angel support. YC subsequently used this momentum to secure funding for a $2 million venture fund, led by Sequoia Capital and the prolific angel investor Ron Conway. With this new infusion of cash, YC will be looking to take more risks and seed more companies. It also opens the door for YC to provide additional capital to previously funded ideas that have gained market traction.

While big companies are cutting back and letting talent go, Graham thinks this is one of the best times ever to start a company. As YC's track record and fresh capital meets a flood of hungry, unemployed talent, an entrepreneurial golden age may be on the horizon. Large caps better keep their Ys open.