Thyroid follicles, the functional units of the thyroid gland, are delineated by a monolayer of thyrocytes resting on a continuous basement membrane. Developmental mechanisms whereby follicles are formed by reorganization of a non-structured mass of non-polarized epithelial cells (folliculogenesis) largely unknown. Here we show that assembly of the epithelial basement membrane is critical for folliculogenesis and is controlled by endothelial cell invasion and by BMP-Smad signaling in thyrocytes. Thyroid-specific double Smad1 and Smad5 knockout mice (Smad1/5dKO) displayed growth retardation, hypothyroidism and defective follicular architecture. In Smad1/5dKO embryonic thyroids, epithelial cells remained associated in large clusters and formed small follicles. Although similar follicular defects are found in VegfaKO thyroids, Smad1/5dKO thyroids had normal endothelial cell density yet impaired endothelial differentiation. Interestingly, both VegfaKO and Smad1/5dKO thyroids displayed impaired basement membrane assembly. Furthemore, conditioned medium (CM) from embryonic endothelial progenitor cells (eEPC) rescued the folliculogenic defects of both Smad1/5dKO and VegfaKO thyroids. Laminin α1β1γ1, abundantly released by eEPC into CM, was critically required for folliculogenesis. Thus, epithelial Smad signaling and endothelial cell invasion promote folliculogenesis via assembly of the basement membrane.