Five Trends That Will Define 2005

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4. Struggling state economies.

Facing massive fiscal crises in 2001, governors and legislators in many states were forced to slash budgets. That hurt the thousands of companies that supply states with goods and services. And it shifted the burden and expense for activities like worker training onto local business leaders.

Fast-forward to today and state revenues have rebounded, but spending remains well below average and many states still face budget holes, incurred by borrowing money or dipping into reserves in previous years. "It would take three or four years of above-average revenue growth for this problem to go away," says Elizabeth McNichol, a senior fellow at the Center on Budget and Policy Priorities, a Washington, D.C., think tank.

While other states struggle with their budgets, California and Florida face unique burdens. The fate of these states is critical to the national economy given that they have historically been hotbeds of entrepreneurship. One fifth of this year's Inc. 500 companies hail from California and Florida. The states are also home to large Hispanic communities, which are increasingly important in terms of new-business formation.

After a quartet of hurricanes battered Florida in 2004, "businesses that do anything relative to cleanup have so much work they can't handle it," says Bill McDermott, director of economic development for Seminole County, "but there are a plethora of businesses sitting around and waiting for customers to come back."

Low-cost loans from the Small Business Administration will sustain companies in the short term. But a big storm can have long-term economic consequences as well. People may move out of a hard-hit area, transforming the work force and tax base. That happened in Homestead, Fla., following Hurricane Andrew in 1992.

Meanwhile, California Gov. Arnold Schwarzenegger is managing his own cleanup of sorts. To appease disgruntled business owners, he's attempting to reform laws such as those that deal with workers' compensation. "The jury is still out," says Jack Kyser, of the Los Angeles County Economic Development Corp., "but the small-business community feels that they have a friend in Sacramento."

5. The return of early-stage deals.

Some good news: A surge in funding for young companies is likely. Venture capital investments increased to an estimated $25 billion this year, according to the National Venture Capital Association, an industry trade group."VCs have been out raising money and they need to put that capital to work," says Tracy Lefteroff, global managing partner of venture capital at PricewaterhouseCoopers in San Jose, Calif. "And the valuations now are more favorable toward the entrepreneur."

There are some caveats. More than ever, investors want to be geographically close to their investment, according to Babson's Spinelli, so businesses in Silicon Valley and Boston will have the upper hand when it comes to landing money. (Live somewhere else? See "Main Street VCs," page 40.)

Also, funds will come in dribs and drabs. "Businesses will see financing in smaller bids and will have to prove a concept before securing more," says Spinelli. With so many other costs ballooning, entrepreneurs will gladly take what they can get.

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