Development of the mammalian external genitalia is controlled by a network of signaling molecules and transcription factors. Because FGF signaling plays a central role in this complicated morphogenetic process, we investigated the role of Sprouty genes, which are important intracellular modulators of FGF signaling, during embryonic development of the external genitalia in mice. We found that Sprouty genes are expressed by the urethral epithelium during embryogenesis, and that they have a critical function during urethral canalization and fusion. Development of the genital tubercle (GT), the anlage of the prepuce and glans penis in males and glans clitoris in females, was severely affected in male embryos carrying null alleles of both Spry1 and Spry2. In Spry1(-/-);Spry2(-/-) embryos, the internal tubular urethra was absent, and urothelial morphology and organization was abnormal. These effects were due, in part, to elevated levels of epithelial cell proliferation in Spry1(-/-);Spry2(-/-) embryos. Despite changes in overall organization, terminal differentiation of the urothelium was not significantly affected. Characterization of the molecular pathways that regulate normal GT development confirmed that deletion of Sprouty genes leads to elevated FGF signaling, whereas levels of signaling in other cascades were largely preserved. Together, these results show that levels of FGF signaling must be tightly regulated during embryonic development of the external genitalia in mice, and that this regulation is mediated in part through the activity of Sprouty gene products.