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In the fall of 2005, Jenova Chen and Kellee Santiago began thinking about creating their own video game company. The two were in their final year as master's students in the Interactive Media Program at the University of Southern California's School of Cinematic Arts, and had just released a video game—Cloud—that they had developed with several other students.[1] The group intended the project as an experiment, meant to reveal whether they could create a game that "expressed something different than video games had in the past", and to determine the public's level of interest in video games of that nature.[2] Due to the game's strongly positive reception, Santiago and Chen began to consider founding their own company, so that they could continue making games like Cloud—in which the design is not based on gameplay mechanics, but on inspiring emotions in players—after they left college.[1]

At the time, digital distribution was gaining popularity. The two saw it as an opportunity to create games without the high financial risk of retail distribution, which they believed would require them to first accumulate funds by working for other video game companies.[1] Thatgamecompany was founded on May 15, 2006, as Chen and Santiago finished their master's degrees.[3][4] The company soon signed a deal with Sony Computer Entertainment, which had been impressed by Chen's Flash game Flow—a component of his master's thesis at USC. Thatgamecompany was contracted to produce three games for the upcoming PlayStation Network distribution system, and was given startup funding and a location at Sony's offices in Los Angeles.[5]

Initially, Thatgamecompany consisted of Chen, Santiago, Nick Clark, who had collaborated with Chen on Flow, and John Edwards. Santiago was the president of the company and the producer for its games, while Clark was the designer and Edwards was the lead engineer.[6] Chen, though co-founding the company, initially worked instead at Maxis on the game Spore.[5]