After negotiating over the past few weeks with Microsoft and signing a letter of intent to be acquired, e-mail startup Xobni has walked from the deal, according to a source close to the negotiations. The deal would have been a natural for Microsoft, which was offering to buy the two-year old startup for somewhere in the $20-million range. (The company has raised less than $5 million so far in venture capital from Khosla Ventures, Atomico, First Round Capital, Ron Conway, and Y Combinator).

But the deeper that Xobni got into the discussions, the less comfortable it felt about its eventual fate inside the Microsoft machine. The fear was that Xobni would end up nothing more than a feature of Outlook. Microsoft wanted the entire team to move up to Redmond, and was vague in its answers about what it had planned for that team, or the product. In the end, the body language just wasn’t there.

Xobni offers a plug-in for Outlook that makes it smarter and easier to use by giving you handy stats in a sidebar and showing you how your contacts are connected to each other. But the company has greater aspirations than to become a feature of Outlook, as its internal integration with Yahoo Mail suggests. The service is still in private beta, and is approaching 50,000 registered users.

Was Xobni crazy to walk away, or did it make the right move in the long run?