Why do some new ventures thrive while others fail? In this study, we investigate the unique relationship between external knowledge sourcing of new ventures and its innovative outcomes, and its contextual embeddedness. The investigation is based on the Knowledge-based view and theory of institutional polycentrism across entrepreneurs, nested in different institutional contexts. Our framework generates hypothesis about the negative impact of higher levels of institutional adversity, on new venture's innovation at the national level. We then found the contingent role of adversity in institutions based on the relationship between external knowledge sourcing and new venture innovation. We examine this question using data from 28,660 entrepreneurs from 47 countries. We use Global Entrepreneurship Monitor, Freedom House, IEF, POLCON and Political Risk Services data for 2009–2013. We apply multilevel estimation framework to test our hypotheses. We find the new ventures that have high level of external knowledge sourcing tend to be more innovative: the ones that search widely through different external sources. Further, we find that the benefits to external knowledge sourcing depend on institutional environmental conditions, however new venture innovation should ensure the external knowledge sourcing are used robustly to develop a resource mechanism to deal with the institutional adversity.