Transforming growth factor β1 (TGFβ1) is shown here to be required for yolk sac haematopoiesis and endothelial differentiation. Mice with a targeted mutation in the TGFβ1 gene were examined to determine the cause of prenatal lethality, which occurs in 50% of homozygous TGFβ1 null (TGFβ1^−/−) conceptions. 50% of TGFβ1^−/− and 25% of TGFβ1^+/− conceptuses were found to die at around 10.5 dpc. The primary defects were restricted to extraembryonic tissues, namely the yolk sac vasculature and haematopoietic system. The embryos per se showed developmental retardation, oedema and necrosis, which were probably secondary to the extraembryonic lesions. The defect in vasculogenesis appeared to affect endothelial differentiation, rather than the initial appearance and outgrowth of endothelial cells. Initial differentiation of yolk sac mesoderm to endothelial cells occurred, but defective differentiation resulted in inadequate capillary tube formation, and weak vessels with reduced cellular adhesiveness. Defective haematopoiesis resulted in a reduced erythroid cell number within the yolk sac. Defective yolk sac vasculogenesis and haematopoiesis were present either together, or in isolation of each other. The phenotypes are consistent with the observation of abundant TGFβ1 gene expression in both endothelial and haematopoietic precursors. The data indicate that the primary effect of loss of TGFβ1 function in vivo is not increased haematopoietic or endothelial cell proliferation, which might have been expected by deletion of a negative growth regulator, but defective haematopoiesis and endothelial differentiation.