Although the relationship of angiosperms to other seed plants remains controversial, great progress has been made in identifying the earliest extant splits in flowering-plant phylogeny, with the discovery that the New Caledonian shrub Amborella trichopoda, the water lilies (Nymphaeales), and the woody Austrobaileyales constitute a basal grade of lines that diverged before the main radiation in the clade. By focusing attention on these ancient lines, this finding has re-written our understanding of angiosperm structural and reproductive biology, physiology, ecology and taxonomy. The discovery of a new basal lineage would lead to further re-evaluation of the initial angiosperm radiation, but would also be unexpected, as nearly all of the ~460 flowering-plant families have been surveyed in molecular studies. Here we show that Hydatellaceae, a small family of dwarf aquatics that were formerly interpreted as monocots, are instead a highly modified and previously unrecognized ancient lineage of angiosperms. Molecular phylogenetic analyses of multiple plastid genes and associated noncoding regions from the two genera of Hydatellaceae identify this overlooked family as the sister group of Nymphaeales. This surprising result is further corroborated by evidence from the nuclear gene phytochrome C (PHYC), and by numerous morphological characters. This indicates that water lilies are part of a larger lineage that evolved more extreme and diverse modifications for life in an aquatic habitat than previously recognized.