This paper provides a formal economic explanation for the existence of venture capital firms. It argues that VCs emerge to solve structural market failures caused by extreme uncertainty and information asymmetry in early-stage innovation. By specializing in screening, monitoring, governance, and value-adding activities, VC firms reduce transaction costs that traditional financial intermediaries cannot absorb. Empirical evidence from Canada supports the theory, showing VC involvement materially improves financing outcomes for high-risk ventures.

This is a foundational academic work that explains why venture capital exists at all — not as a cultural phenomenon, but as an institutional solution to broken capital markets. It underpins much of modern VC thinking around active ownership, board control, staged financing, and governance, making it essential reading for LPs, policymakers, and advanced practitioners.