In the adult intestine, an organized array of finger-like projections, called villi, provide an enormous epithelial surface area for absorptive function. Villi first emerge at embryonic day (E) 14.5 from a previously flat luminal surface. Here, we analyze the cell biology of villus formation and examine the role of paracrine epithelial Hedgehog (Hh) signals in this process. We find that, before villus emergence, tight clusters of Hh-responsive mesenchymal cells form just beneath the epithelium. Cluster formation is dynamic; clusters first form dorsally and anteriorly and spread circumferentially and posteriorly. Statistical analysis of cluster distribution reveals a patterned array; with time, new clusters form in spaces between existing clusters, promoting approximately four rounds of villus emergence by E18.5. Cells within mesenchymal clusters express Patched1 and Gli1, as well as Pdgfr alpha, a receptor previously shown to participate in villus development. BrdU-labeling experiments show that clusters form by migration and aggregation of Hh-responsive cells. Inhibition of Hh signaling prevents cluster formation and villus development, but does not prevent emergence of villi in areas where clusters have already formed. Conversely, increasing Hh signaling increases the size of villus clusters and results in exceptionally wide villi. We conclude that Hh signals dictate the initial aspects of the formation of each villus by controlling mesenchymal cluster aggregation and regulating cluster size.