This article examines how knowledge management (KM) affects innovation performance within biotechnology firms. This is an industry in which small- and medium-sized biotech enterprises live together with the biotech divisions of large pharmaceutical firms. We conceptualize KM as a set of practices and dynamic capabilities, and hypothesize that KM dynamic capabilities act as a mediating variable between KM practices and innovation performance. We use structural equation modelling to test the hypotheses on a data set from the biotechnology industry. The results support our conceptualization and demonstrate its utility in explaining differences in innovation performance across firms. Findings have important implications regarding KM and innovation in high-tech small- and medium-sized enterprises.