Nerve net formation was examined during head-regeneration and budding of Hydra using indirect immunofluorescence on whole mounts. The nerve net was visualized with an antiserum to a neuropeptide, RFamide. The nerve net forms in two steps: the first is the appearance of ganglion cells at the regenerating tip, and the second is the appearance of sensory cells at the apex and the simultaneous disappearance of ganglion cells from the apex. The behavior of epithelial cells during head-regeneration, as defined by monoclonal antibody TS19, corresponded with nerve net formation. We examined nerve net formation in 3 morphogenetic mutants: a head-regeneration deficient mutant (reg-16), a budding deficient mutant (L4) and a multi-headed mutant (mh-1). In addition, we also examined chimeric strains which consist of the epithelial cells from the wild type and nerve cells from a mutant, and vice versa. We obtained clear evidence that nerve net formation is controlled by the environment provided by the epithelial cells.