After the hardcore punk group Minor Threat dissolved, Ian MacKaye (vocals and guitar) was active with a few short-lived groups, most notably Embrace. MacKaye decided he wanted a project that was "like The Stooges with reggae", but was wary about forming another band after Embrace's break up. MacKaye recalled, "My interests were not necessarily to be in a band, but to be with people who wanted to play music with me."  MacKaye recruited ex-Dag Nasty drummer Colin Sears and bass guitarist Joe Lally, and the trio began practicing together in September 1986. After a few months of rehearsals, Sears returned to Dag Nasty and was replaced by Brendan Canty (earlier of Rites of Spring). One day Canty's Rites of Spring bandmate Guy Picciotto dropped by during a practice session to see how his friend was getting along; he later admitted he secretly harbored the idea of joining the group. But Picciotto was disappointed that there seemed to be no place for him.  After some uncertainty from Canty about what he wanted to do with his future, the trio regrouped and booked their first show at the Wilson Center in early September 1987. The group still needed a name, so MacKaye chose the word "fugazi" from Mark Baker's Nam, a compilation of stories of Vietnam War veterans, it there being a slang acronym for "Fucked Up, Got Ambushed, Zipped In [into a body bag]".  The band began inviting Picciotto to practices. Inspired by use of a foil in hip hop, Picciotto sang backup vocals. After his band Happy Go Licky broke up, he became more involved with Fugazi. MacKaye eventually asked Picciotto to become a full member, which he accepted.

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