Testicular Leydig cells produce testosterone and provide the hormonal environment required for male virilization and spermatogenesis. In utero, fetal Leydig cells (FLCs) are necessary for the development of the Wolffian duct and male external genitalia. Steroidogenic factor 1 (Sf1) is a transcriptional regulator of hormone biosynthesis genes, thus serving a central role in the Leydig cell. Desert hedgehog (Dhh), a Sertoli cell product, specifies the FLC lineage in the primordial gonad through a paracrine signaling mechanism. Postnatally, FLCs are replaced in the testis by morphologically distinct adult Leydig cells (ALCs). To study a putative interaction between Sf1 and Dhh, we crossed Sf1 heterozygous mutant mice with Dhh homozygous null mice to test the function of these two genes in vivo. All of the compound Sf1(+/-); Dhh(-/-) mutants failed to masculinize and were externally female. However, embryonic gonads contained anastomotic testis cords with Sertoli cells and germ cells, indicating that sex reversal was not attributable to a fate switch of the early gonad. Instead, external feminization was attributable to the absence of differentiated FLCs in XY compound mutant mice. ALCs also failed to develop, suggesting either a dependence of ALCs on the prenatal establishment of Leydig cell precursors or that Sf1 and Dhh are both required for ALC maturation. In summary, this study provides genetic evidence that combinatorial expression of the paracrine factor Dhh and nuclear transcription factor Sf1 is required for Leydig cell development.