Members of the Hedgehog (Hh) family of secreted signaling proteins function as potent short-range organizers in animal development. Their range of action is limited by a C-terminal cholesterol tether and the upregulation of Patched (Ptc) receptor levels. Here we identify a novel segment-polarity gene in Drosophila, dispatched (disp), and demonstrate that its product is required in sending cells for normal Hh function. In the absence of Disp, cholesterol-modified but not cholesterol-free Hh is retained in these cells, indicating that Disp functions to release cholesterol-anchored Hh. Despite their opposite roles, Disp and Ptc share structural homology in the form of a sterol-sensing domain, suggesting that release and sequestration of cholesterol-modified Hh may be based on related molecular pathways.