Subscribe to Entrepreneur for $5

Watching YouTube

From a garage to Google: how YouTube became the biggest entrepreneurial success story of 2006

Opinions expressed by Entrepreneur contributors are their own.

It began in a garage in Menlo Park, California. Three twentysomethings were hanging out, chatting about a party they'd gone to the night before. They'd taken some video footage at the party and were hoping to share it with friends but couldn't figure out how to get it online. So they set out to find a way to do just that.

On Monday, October 9, announced that it had paid $1.65 billion in stock for the purchase of , the sharing service started by , Steve Chen and Jawed Karim. In just over a year and a half, the three partners turned a simple concept into an astoundingly popular site, one that serves more than 100 million videos per day, with more than 65,000 videos being uploaded daily. According to site tracking firm Hitwise, 60 percent of all videos watched online are clips from YouTube. Not bad for a 19-month-old company.

So just how did YouTube become an online sensation? This online video service incorporates a heavy dose of social networking that turns users into fanatics. Users upload their own clips (with many being snatched from TV and other media), and the site allows others to post comments and rate the clips, as well as embed the videos on their own blogs. The site has created YouTube celebrities, like lonelygirl15, and allowed buzzed-about TV clips--like the notorious recent Fox News interview with former president Bill Clinton--to spread like wildfire. And like other popular Web 2.0 services, it's intuitive and easy to use.

While this deal is an amazing coup for the three founders, the future success of this venture isn't guaranteed. Copyright concerns and an unproven business model raise some question as to just how much money and effort Google will have to invest in this business to keep the momentum going.

Back to the Beginning
Exactly how did these three former PayPal employees create Web 2.0's biggest success so far? After registering the domain on February 15, 2005, the partners spent a few months on site development and released a test version of YouTube to the public in May 2005. This initial beta version primarily featured videos of Chen's cat, PJ.

To get their website some buzz beyond their inner circle of friends, the partners came up with a contest that awarded an iPod Nano to a random YouTube member every day for two months. They used a point-based system--for example, giving users one point for signing up, one for inviting others to join and one for submitting a video. The more points you gained, the better your chance of winning the iPod. This contest generated the traffic YouTube needed to make it one of the fastest-growing sites around: By September 2005, users were viewing YouTube videos more than a million times a day.

But sites can't run on visitor views alone. And that's where the partners' PayPal connections came into play. After former PayPal CFO Roelof Botha ran into Chen at a party in 2005, he decided to put some clips from his Italian honeymoon on YouTube. As the number of visitors skyrocketed, Botha, now a partner at firm (known for backing Google, Apple and Yahoo!), started looking at the site from an investor's perspective.

With Chen's credit card maxed out on business expenses, the partners knew they needed an influx of cash. Botha convinced Sequoia Capital to invest, and the VC firm stepped up in November 2005 with $3.5 million in funding. With serious capital in place, the partners officially launched the site to the public in December that year. The number of views soon reached three million a day.

In April of 2006, YouTube received an additional $8 million in a second round of funding from Sequoia Capital. Since then, the site's continued to pick up steam, quickly becoming one of the most popular destinations on the net.

Is The Future As Bright as They Say?
Despite the fact that YouTube has never generated a profit and, in fact, is rumored to be losing $500,000 a month, Google sees limitless income (read: advertising) opportunities with the popular site. Hurley and Chen will continue to operate the company, while reporting to their Google superiors. (Prior to the acquisition, Karim left the company to pursue an advanced degree at Stanford though he is still involved with YouTube and was given a piece of the acquisitional funding.)

Yet there are still questions about the long-term viability of YouTube. First is the unproven business model. The traffic is there, but will advertisers follow at a pace that will allow the company to break even? (It's rumored the company spends more than $1 million per month in hosting charges.) Google's experience with online advertising should be a boon in this area.

And Google will no doubt have to deal with numerous copyright infringement lawsuits as a result of eager users uploading the latest TV and movie clips. So far, YouTube has only been hit with one lawsuit by a California journalist over copyright infringement. But the site has also had to take down several videos to settle copyright matters, which YouTube does when content owners request it. Another good sign, however, is that some major companies understand the power of YouTube's audience and upload their own clips to generate buzz or test out ideas.

In spite of these doubts, YouTube can easily be designated a prime example of Web 2.0 success. The companies in this second swell of online enterprises actively involve their users, encourage social networking, make use of technology like RSS feeds, and facilitate user-created content.

With the plethora of like-minded young companies like Facebook, MySpace, Wikipedia and Flickr emerging, the big response they're seeing, and the many acquisitions by major players like Google, News Corp. and Yahoo!, this points to a second wave for dotcom startups reminiscent of the IPO frenzy before the bubble burst in 2001. But this time, investors are more cautious, so the competition is much fiercer amongst startups. After 2001, most venture capitalists turned away from young companies, instead seeking out more mature companies with older, more experienced management teams and proven business models. But after stocks came back to life in 2004, venture capitalists have once again been spotting--and latching on to--young talent like Hurley and Chen.

So what's next for YouTube? Yahoo! is already snapping at their heels, having recently upgraded its video service to allow consumers to submit videos directly to it. But Chen and Hurley are prepared: They say consumers will be able to view YouTube clips on phones and other devices sometime in the very near future. And, they say, there's a chance they'll expand YouTube beyond video to audio and other content. And of course, Google offers its own viral video service, so you have to wonder if the two services will eventually be integrated or if one will be discontinued or morphed into something else.

There are yet more questions: Will some users be driven away by the potential increase in advertising and promotions? Will the Google connection take away from the site's somewhat edgy feel, a characteristic that attracted many users to the site in the first place? How will the site create a sustainable profit? Is the $1.65 billion acquisition of a company with an unproven business model a sign of another bubble?

Time will tell what the future holds for YouTube and its founders, but Hurley, Chen and Karim have certainly locked in their place in internet history as protagonists in the biggest overnight success story in recent memory.

Entrepreneur Editors' Picks