The Hedgehog (HH) pathway is critical for development and adult tissue homeostasis. Aberrant HH signaling can lead to congenital malformations and diseases including cancer. Although cholesterol and several oxysterol lipids have been shown to play crucial roles in HH activation, the molecular mechanisms governing their regulation remain unresolved. Here, we identify Canopy4 (CNPY4), a Saposin-like protein, as a regulator of the HH pathway that modulates levels of membrane sterol lipids. Cnpy4 embryos exhibit multiple defects consistent with HH signaling perturbations, most notably changes in digit number. Knockdown of Cnpy4 hyperactivates the HH pathway in vitro and elevates membrane levels of accessible sterol lipids, such as cholesterol, an endogenous ligand involved in HH activation. Our data demonstrate that CNPY4 is a negative regulator that fine-tunes HH signal transduction, revealing a previously undescribed facet of HH pathway regulation that operates through control of membrane composition.