Lipoprotein biogenesis is essential for bacterial survival. Phosphatidylglycerol:prolipoprotein diacylglyceryl transferase (Lgt) is an integral membrane enzyme that catalyses the first reaction of the three-step post-translational lipid modification. Deletion of the lgt gene is lethal to most Gram-negative bacteria. Here we present the crystal structures of Escherichia coli Lgt in complex with phosphatidylglycerol and the inhibitor palmitic acid at 1.9 and 1.6 Å resolution, respectively. The structures reveal the presence of two binding sites and support the previously reported structure-function relationships of Lgt. Complementation results of lgt-knockout cells with different mutant Lgt variants revealed critical residues, including Arg143 and Arg239, that are essential for diacylglyceryl transfer. Using a GFP-based in vitro assay, we correlated the activities of Lgt with structural observations. Together, the structural and biochemical data support a mechanism whereby substrate and product, lipid-modified lipobox-containing peptide, enter and leave the enzyme laterally relative to the lipid bilayer.