During murine peri-implantation development, the egg cylinder forms from a solid cell mass by the apoptotic removal of inner cells that do not contact the basement membrane (BM) and the selective survival of the epiblast epithelium, which does. The signaling pathways that mediate this fundamental biological process are largely unknown. Here we demonstrate that Rac1 ablation in embryonic stem cell-derived embryoid bodies (EBs) leads to massive apoptosis of epiblast cells in contact with the BM. Expression of wild-type Rac1 in the mutant EBs rescues the BM-contacting epiblast, while expression of a constitutively active Rac1 additionally blocks the apoptosis of inner cells and cavitation, indicating that the spatially regulated activation of Rac1 is required for epithelial cyst formation. We further show that Rac1 is activated through integrin-mediated recruitment of the Crk-DOCK180 complex and mediates BM-dependent epiblast survival through activating the phosphatidylinositol 3-kinase (PI3K)-Akt signaling pathway. Our results reveal a signaling cascade triggered by cell-BM interactions essential for epithelial morphogenesis.