The multilineage differentiation capacity of mouse embryonic stem (ES) cells offers a potential testing platform for gene products that mediate mammalian lineage determination and cellular specialization. Identification of such differentiation regulators is crucial to harnessing ES cells for pharmaceutical discovery and cell therapy. Here we describe the use of episomal expression technology for functional evaluation of cDNA clones during ES-cell differentiation in vitro. Several candidate cDNAs identified by subtractive cloning and expression profiling were introduced into ES cells in episomal expression constructs. Subsequent differentiation revealed that the Wnt antagonist Sfrp2 stimulates production of neural progenitors. The significance of this observation was substantiated by forced expression of Wnt-1 and treatment with lithium chloride, both of which inhibit neural differentiation. These findings reveal the importance of Wnt signaling in regulating ES-cell lineage diversification. More generally, this study establishes a path for rapid and direct validation of candidate genes in ES cells.