Small and medium enterprises (SMEs) are constantly confronting formidable and competitive challenges. In their midst, to stay abreast of larger firms or international markets, a small number is still able to insulate themselves fromthe pervasive effects of competition, technology advancement and dynamic environments. These SMEs have to be flexible and adaptive, which necessitates technical skills, knowledge and capacity to survive as viable entrepreneurial organisations. Many SMEs face difficulties in responding to such challenges because they lack the absorptive capacity or capabilities in the organisation. This study focuses on how virtual or knowledge networks can build innovative capabilities in SMEs and investigates the absorptive capacity evident to facilitate capability development through a mentoring program. The data collected involved a series of interviews and workshops with firms, mentors and local and state government representatives.