Every college will take on an "entrepreneurship champion" to raise business awareness, boost staff development and bring more enterprise into the curriculum.
Grants will be made available to help students and graduates set up businesses and the fund will encourage partnerships to develop innovative work-based training.
The available funding will be increased to pound;10m next year, and colleges are likely to take on people from industry for the new positions.
Wil Edmunds, principal of Deeside College, Flintshire, and a board member of Fforwm, has welcomed the new initiative.
"In rural economies, it is very difficult to break into a small to medium-sized market. The purpose of the Knowledge Exploitation Fund is to do just that," he said.
"It's a very positive development to appoint somebody withineach institution. But you're going to have up to 30 institutions looking for these knowledge entrepreneurs, so that will be a problem in itself."
A study by the Further Education Development Agency in Wales, and Fforwm, which represents Welsh FE colleges, is urging measures to encourage colleges to meet the needs of all small businesses in Wales.
The report says colleges need to address the unprecedented impact of technology and e-commerce on industry and recommends wider dissemination of good practice, more FE staff in industry placements and mentoring among college staff.
Feda has also urged Welsh colleges to channel more support in information and communication technology to small businesses.
Last year, the National Assembly published its survey, Future Skills Wales, in which almost a fifth of employers reported a skills gap among their workforce.
It has been estimated that nearly half of the working-age population in Wales have poor numeracy, while more than 18 per cent have poor reading skills.
Further reports, page 8