The membrane protein Dispatched (Disp), which belongs to the RND family of small molecule transporters, is essential for Hedgehog (Hh) signaling, by catalyzing the extracellular release of palmitate- and cholesterol-modified Hh ligands from producing cells. Disp function requires Furin-mediated proteolytic cleavage of its extracellular domain, but how this activates Disp remains obscure. Here, we employ cryo-electron microscopy to determine atomic structures of human Disp1 (hDisp1), before and after cleavage, and in complex with lipid-modified Sonic hedgehog (Shh) ligand. These structures, together with biochemical data, reveal that proteolytic cleavage opens the extracellular domain of hDisp1, removing steric hindrance to Shh binding. Structure-guided functional experiments demonstrate the role of hDisp1–Shh interactions in ligand release. Our results clarify the mechanisms of hDisp1 activation and Shh morphogen release, and highlight how a unique proteolytic cleavage event enabled acquisition of a protein substrate by a member of a family of small molecule transporters.