Horsley was born in Holderness in the East Riding of Yorkshire. He was the eldest son of Nicholas Horsley, the chairman of Northern Foods from 1970 until the role was assumed by Christopher Haskins; the company had been founded by Nicholas's father, Alec. According to Horsley's autobiography, Dandy in the Underworld, his birth name was Marcus, but his mother had decided to change it to Sebastian by the time she had returned from the hospital. His name was officially changed by deed poll in 1967.

Horsley had an older sister, a psychotherapist named Ashley, as well as a younger brother, Jason Horsley. His mother, the former Valerie Edwards, was a Welsh typist. After his parents' divorce, Horsley's father married Sabitha Sarkar (married 1975-1987) and Alwyne Law (married 1998). His mother did not remarry but later became known as Valerie Walmsley-Hunter.

His parents, both of whom were alcoholics, divorced in 1975. As Horsley wrote in his memoirs, "Clearly everyone in my life who should have been vertical was horizontal". In an interview she gave to The Sunday Times, Horsley's mother admits that her son's childhood was profoundly difficult, saying, "I don't think Nicholas ever went to bed sober and I was always in a fog. Sebastian and my other two children were accidents and, though it seems shocking to admit, I drank all the way through my pregnancies."

In 1983, Horsley married Evelynn Smith (born Evelynn Anne Smith), the daughter of a Scottish painter and decorator, and who, together with Meriel Scott, constituted the art and furniture-design company Precious McBane. Horsley and Smith separated in 1990 and Smith died of an aneurysm in 2003, at age 40.

Horsley lived at 7 Meard Street, London, where the sign on the door read: "This Is Not A Brothel / There Are No Prostitutes At This Address".

In August 2000 Horsley travelled to the Philippines to experience a crucifixion, in order to prepare for a series of paintings on the topic. Refusing pain killers, he was nailed to a cross and passed out. The foot rest broke and he only avoided serious injury by being caught by onlookers. A film and photos of the event, as well as his subsequent paintings of crosses, were exhibited in London in 2002.

In an editorial article in The Observer in 2004, he described his preference for sex with prostitutes, writing "What I hate with women generally is the intimacy, the invasion of my innermost space, the slow strangulation of my art." He also stated that he himself had worked as a prostitute for a while. He argued that prostitution should not be legalized, as that would take away part of its thrill.

Horsley ran a monthly column in the Erotic Review from 1998 to 2004. In early 2006, Horsley together with Marion McBride began to run a weekly sex advice column in The Observer. Four months later, after graphic discussions of oral and anal sex had led to numerous complaints from outraged readers, the column was discontinued.

Horsley, a self-described dandy, praised his chosen home of Soho in an article in 2006, though he had grown increasingly unhappy at what he saw as the decline of Soho as a centre of loose morals and bohemian bars, bemoaning the closure of haunts such as the Colony Room. Speaking following the death of the Colony Room's last proprietor Michael Wojas in June 2010, a week before his own death, he told The Independent: " The air used to be clean and the sex used to be dirty. Now it is the other way around. Soho has lost its heart."

In September 2007, the Spectrum London gallery staged Hookers, Dealers, Tailors, a retrospective by Horsley. The show documented his diving in Australian shark-infested water and copiously ingesting deadly drugs.

His memoir, Dandy in the Underworld, named after the T.Rex album of same name (Horsley counted Marc Bolan as one of his idols) was published in the UK by Sceptre in September 2007 and in the USA in March 2008 from Harper Perennial. In it, he claims to have had an affair with the Scottish gangster-turned-artist Jimmy Boyle. Horsley further stated that his late wife, Evelynn, also had an affair with Boyle, who served as best man at the couple's wedding, according to Horsley's mother.

A one-man play, Dandy in the Underworld, written and directed by Tim Fountain opened at the Soho Theatre in London on 15 June 2010, one day prior to Horsley's death. The role of Horsley (the sole character in the play) is performed by Milo Twomey.

Horsley was denied entry into the United States on 19 March 2008, after arriving at Newark Airport for a book tour. Immigration officers denied his entry claiming issues of moral turpitude. A customs official said that "...travellers who have been convicted of a crime involving moral turpitude (which includes controlled-substance violations) or admit to previously having a drug addiction are not admissible...". After eight hours of questioning, he was placed on a plane and sent back to London. Horsley had told the Associated Press that he had prepared for the visit; his one concession: removing his nail polish.

Horsley was found dead at his London home on 17 June 2010 of a heroin and cocaine overdose. A friend, the journalist Toby Young, said he believed Horsley's death was an accident: " If it had been suicide Sebastian would not have passed up the opportunity to write a note. It's a tragic loss of life." In an interview in April 2008, Horsley romanticised dying "destitute in the arms of a prostitute," though not immediately dying "if that's alright with you."

His funeral took place on July 1, 2010, at St James's, Piccadilly, and was attended by more than 400 mourners, among them Marc Almond and the writer Will Self. Horsley's coffin arrived at the church in a horse-drawn hearse. Among those who paid tribute to him were Stephen Fry who spoke of his friend's "essential sweetness" and his "brown eyes" that stopped "just short of pleading". The coffin was carried out of the church to the strains of Marc Bolan's 20th Century Boy.

At the inquest on 17 August 2010 the Westminster Coronor, Dr. Paul Knapman, decided that "[Horsley] was known to have abused drugs and to that extent he has been the author of his own misfortune."