Epithelial cancer constitutes a major clinical challenge and molecular mechanisms underlying the process of tumour initiation are not well understood. Here we demonstrate that hair follicle bulge stem cells (SCs) give rise to well-differentiated sebaceous tumours and show that SCs are not only crucial in tumour initiation, but are also involved in tumour plasticity and heterogeneity. Our findings reveal that SC-specific expression of mutant Lef1, which mimics mutations found in human sebaceous tumours, drives sebaceous tumour formation. Mechanistically, we demonstrate that mutant Lef1 abolishes p53 activity in SCs. Intriguingly, mutant Lef1 induces DNA damage and interferes with SC-specific gatekeeper functions normally protecting against accumulations of DNA lesions and cell loss. Thus, normal control of SC proliferation is disrupted by mutant Lef1, thereby allowing uncontrolled propagation of tumour-initiating SCs. Collectively, these findings identify underlying molecular and cellular mechanisms of tumour-initiating events in tissue SCs providing a potential target for future therapeutic strategies.