Union Square Looks to Raise Third Fund

Union Square Ventures is preparing to raise a third fund, according to multiple sources familiar with the situation.

Several sources say that the New York-based firm plans to raise twice the size as its previous fund, a $156 million fund that closed in 2008—with one source pegging the amount at $500 million.

But firm co-founder Fred Wilson dismissed talk of a large fund. “The rumors of USV raising a large fund are categorically false,” he wrote in an email. “We will never raise a large fund. We like the small fund model and are completely and totally committed to it.”

Wilson added: “Whomever you got that information from is a lousy source and I suggest you stop listening to them.”

If USV were to raise half a billion dollars, it would mark a major shift for the firm, which raised a debut fund of $125 million in 2004 and then kept its second fund small four years later.

Union Square has stayed small despite racking up some impressive exits and a portfolio that includes major Internet companies, such as Twitter and Zynga Game Network.

On a Roll

The firm’s exits include Tacoda, which sold to AOL in 2007 for a reported $300 million; Feedburner, which Google acquired in 2007 for a reported $100 million; and Del.icio.us, which Yahoo bought in 2005 for a reported $30 million.

USV’s first fund “is a hall of famer,” says John Borthwick, CEO of New York-based tech incubator Betaworks. “[USV co-founder] Fred Wilson has made some of the most astute, well-timed, and well-placed investments of anyone over the last five years.”

The rumors of USV raising a large fund are categorically false. We will never raise a large fund. We like the small fund model and are completely and totally committed to it.

Fred Wilson

USV’s first fund had an IRR of 57.7% as of June 30, according to the Oregon Public Employees Retirement System, a limited partner in the fund. The IRR for USV’s second fund is not meaningful because it is so young, according to the state pension fund.

In addition to Twitter and Zynga, USV also has stakes in some other hot companies. For example, when Etsy, a New York-based marketplace for handmade crafts, raised a $20 million round in August, the financing came at a $300 million pre-money valuation. (The 5-year-old company has raised $51.6 million altogether.)

USV portfolio company Boxee is widely considered a strong contender to such big companies as Google and Apple. The New York-based startup sells an open-source gadget that connects users’ TVs to the Internet, allowing them to access video, music and sundry other applications. Besides USV, Boxee’s backers include Spark Capital and General Catalyst Partners.

USV and Spark Capital were also the earliest—and until recently—the only investors in the fast-growing blogging platform Tumblr, which last month raised a new and reportedly “very competitive” and undisclosed round of financing from Sequoia Capital.

The round apparently was so aggressive that Wilson said in his blog that consumer Web investing has grown too heated.

Unnatural Acts

“The competition for ‘hot’ deals is making people crazy and I am seeing many more unnatural acts from investors happening,” Wilson blogged. “If it were just valuations rising quickly, I’d be a bit less concerned. But we are also seeing large deals ($5 million to $15 million) getting done in a few days with little or no due diligence. Investors are showing up at the first meeting with term sheets. I have never seen phases like this end nicely.”

While plenty of investors could get burned by the frenzy, Union Square hopes to avoid it by sticking to its strategy of betting on winners as early as possible. In January 2008, when social gaming powerhouse Zynga raised its $10 million Series A, Union Square Ventures was there. And when Twitter raised its $5 million Series A in July 2007, one of its first checks came from Union Square.

It’s largely because of the breakaway successes of Zynga and Twitter that the firm could easily make the case to investors that it needs more capital. Already, Zynga has raised $519 million over three more rounds, while Twitter has raised $160 million and is expected to raise more before eventually going public. —Constance Loizos