We address the mechanisms underlying generation of skeletal muscle, smooth muscle, and endothelium from epithelial progenitors in the dermomyotome. Lineage analysis shows that of all epithelial domains, the lateral region is the most prolific producer of smooth muscle and endothelium. Importantly, individual labeled lateral somitic cells give rise to only endothelial or mural cells (not both), and endothelial and mural cell differentiation is driven by distinct signaling systems. Notch activity is necessary for smooth muscle production while inhibiting striated muscle differentiation, yet it does not affect initial development of endothelial cells. On the other hand, bone morphogenetic protein signaling is required for endothelial cell differentiation and/or migration but inhibits striated muscle differentiation and fails to impact smooth muscle cell production. Hence, although different mechanisms are responsible for smooth muscle and endothelium generation, the choice to become smooth versus striated muscle depends on a single signaling system. Altogether, these findings underscore the spatial and temporal complexity of lineage diversification in an apparently homogeneous epithelium.