Dorsoventral patterning of the Drosophila embryo is regulated by graded distribution of bone morphogenetic proteins (BMPs) composed of two ligands, decapentaplegic (Dpp) a BMP2/4 ortholog and screw (Scw) a BMP5/6/7/8 family member. scw(E1) encodes an unusual allele that was isolated as a dominant enhancer of partial loss-of-function mutations in dpp. However, the molecular mechanisms that underlie this genetic interaction remain to be addressed. Here we show that scw(E1) contains a mutation at the furin cleavage site within the prodomain that is crucial for ligand production. Furthermore, our data show that Scw(E1) preferentially forms heterodimers with Dpp rather than homotypic dimers, providing a possible explanation for the dominant negative phenotype of scw(E1) alleles. The unprocessed prodomain of Scw(E1) remains in a complex with the Dpp:Scw heterodimer, and thus could interfere with interaction of the ligand with the extracellular matrix, or the kinetics of processing/secretion of the ligand in vivo. These data reveal novel mechanisms by which post-translational regulation of Scw can modulate Dpp signaling activity.