McLeod said he was leaving the race because he and Sheheen's agendas were so closely aligned that he worried the primary could become divisive.
"The last thing I want to happen is for a divisive primary to cost us a general election," McLeod said. If "this is the best way for me to serve my state at this time, then this is exactly what I'm going to do."
McLeod said fundraising wasn't the reason he was leaving the race, though he raised about half the campaign cash Sheheen has amassed.
Speculation had grown that McLeod was exiting the race to run against Republican U.S. Sen. Jim DeMint, but McLeod said he's not seeking any other office in 2010.
Sheheen and McLeod were the earliest entrants in a race to replace Republican Gov. Mark Sanford, who can't seek a third term by law.
Sheheen called his endorser and former competitor "an important conscience of the campaign trail" and "the best speaker on the stump."
"That is true," McLeod quipped at a news conference.
McLeod is the first to exit what had been a five-way race among Democrats. Republicans had their first casualty of the race last month when state Sen. Larry Grooms dropped out of the GOP's five-way race. The primaries are June 8.
Candidates have said raising money has been tough, though Sheheen reported in January he had raised $958,319. Columbia lobbyist and lawyer Dwight Drake reported $510,418, while McLeod had raised $482,185.
McLeod said money wasn't the reason he was leaving, noting he had $366,806 cash on hand at the end of the fourth quarter in December. He wasn't sure what he'd do with money remaining.
"You know, I thought about going to Argentina with it," McLeod said in a dig at Sanford, who confessed in June to an affair with an Argentine woman. The crack brought laughter from a crowd of Democrats.