Fibro-adipogenic progenitors (FAPs) are an interstitial cell population in adult skeletal muscle that support muscle regeneration. During development, interstitial muscle connective tissue (MCT) cells support proper muscle patterning, however the underlying molecular mechanisms are not well understood and it remains unclear whether adult FAPs and embryonic MCT cells share a common lineage. We show here that mouse embryonic limb MCT cells expressing the transcription factor Osr1, differentiate into fibrogenic and adipogenic cells in vivo and in vitro defining an embryonic FAP-like population. Genetic lineage tracing shows that developmental Osr1⁺ cells give rise to a subset of adult FAPs. Loss of Osr1 function leads to a reduction of myogenic progenitor proliferation and survival resulting in limb muscle patterning defects. Transcriptome and functional analyses reveal that Osr1⁺ cells provide a critical pro-myogenic niche via the production of MCT specific extracellular matrix components and secreted signaling factors.