Hedgehog (Hh) proteins comprise a family of secreted signaling molecules essential for patterning a variety of structures in animal embryogenesis. During biosynthesis, Hh undergoes an autocleavage reaction, mediated by its carboxyl-terminal domain, that produces a lipid-modified amino-terminal fragment responsible for all known Hh signaling activity. Here it is reported that cholesterol is the lipophilic moiety covalently attached to the amino-terminal signaling domain during autoprocessing and that the carboxyl-terminal domain acts as an intramolecular cholesterol transferase. This use of cholesterol to modify embryonic signaling proteins may account for some of the effects of perturbed cholesterol biosynthesis on animal development.