Drosophila sensory organ precursor (SOP) cells undergo several rounds of asymmetric cell division to generate the four different cell types that make up external sensory organs. Establishment of different fates among daughter cells of the SOP relies on differential regulation of the Notch pathway. Here, we identify the protein Lethal (2) giant discs (Lgd) as a critical regulator of Notch signaling in the SOP lineage. We show that lgd encodes a conserved C2 domain protein that binds to phospholipids present on early endosomes. When Lgd function is compromised, Notch and other transmembrane proteins accumulate in enlarged early endosomal compartments. These enlarged endosomes are positive for Rab5 and Hrs, a protein involved in trafficking into the degradative pathway. Our experiments suggest that Lgd is a critical regulator of endocytosis that is not present in yeast and acts in the degradative pathway after Hrs.