This study investigates the relationship between organizational factors and innovation capacity in software development companies. By means of this investigation this paper aims to determine the organizational factors that have significant impact on the innovation capacity of companies. For this purpose an empirical research including 91 small and medium sized software development companies was conducted. A factor analysis and regression based methodology were used to analyze the collected data. The study reveals that the innovative software companies regard three basic predictors significantly important for innovation capacity. Idea generation and human resource impacted the innovation capacity positively. However, the third predictor, cross-functional integration impacted the innovation capacity negatively. (C) 2007 Elsevier Ltd. All rights reserved.