(FORTUNE Small Business) – Once upon a time, in the late 1980s to be exact, CE Software struck it rich with software programs that allowed people to send e-mail and do other nifty tasks with their personal computers. Big corporations, including Disney and Lockheed, lined up to buy from the tiny company located in the cornfields of Iowa. And thus, CE's founders saw a future as a publicly traded powerhouse and yearned for all the goodies (namely, stock options) that go along with a hot tech company. As it turned out--hit software or no hit software--Wall Street wouldn't even glance at a company as small as CE, which was then pulling in only $3 million in revenues. So the founders hit upon a novel solution: merging their company with the empty shell of one that had little more in assets than a listing on the Nasdaq. Instant public company! Instant riches!

But for now there's no happy ending to this tale. A year or two after its merger in 1990, CE drifted into a period of bad decisions. Revenues have been shrinking for years (1999 revenues were $3.8 million, down from 1995's $12.9 million), and the company has posted losses for all but two of the past seven years. Efforts to develop new products have failed. Two acquisitions turned out to be duds. Customers have drifted. Christian Gurney, the soft-spoken, 35-year-old chief of the holding company, acknowledges that the company has been dying. Perhaps CE's execs should have paid more attention to the name of the shell company they merged with, Anubis. As it turns out, Anubis was a fearsome figure in ancient Egypt. Half man and half jackal, it was the god who led the dead to judgment.

No one knows, or cares much, for that matter, what will become of CE. In a desperate move to revive the company, CE agreed in late December to merge with ATIO Corp. of Minneapolis, a small, privately held company that has a product that provides customer-service support for e-commerce businesses. Whether this combination will work is anyone's guess. Still, CE's experience is a great case study for any small company that enters the chaotic high-tech market. The lessons: Don't hitch your future to the success of one or two products in a market that might morph overnight; don't buy only technology--also buy the people who created it; and remember that hiring tech talent is that much harder when you're located in Iowa--or any other rural outpost far from the hot spots of Silicon Valley or Boston's Route 128.

What went wrong at CE? And who's to blame? Some would say management, for lacking the vision and the ability to lead the company into new markets when it became apparent that its two best-selling programs were running out of steam. Others would point to a market that shifts directions as swiftly, unpredictably, and destructively as a tornado. And some would say that the company just had a run of bad luck. Really bad luck.

CE had modest beginnings. It was founded in the attic of a computer store in Des Moines in 1981. The store sold Apple IIs, and a local college kid who hung out there, Donald Brown, started writing games and other programs for the machine. The kid was hired when thousands of the programs started to sell, and he later became one of three founders. Thus, CE Software was born. But the early years were rocky. Sue Nail, the company's public relations manager, recalls how CE had to sell furniture and office supplies in order to meet the payroll the week she was hired in mid-1988.

But success would come like a tsunami within months. CE launched QuicKeys, which allowed people to automate computer tasks. Shortly after that came QuickMail, an e-mail program for the Macintosh. With QuickMail, CE scored an astonishing coup: It snatched some of the e-mail market away from Microsoft. By 1990, CE had a roster of big-name customers clamoring for its products--among them, in addition to Disney and Lockheed, were Citibank and Northern Telecom. On that high note, CE decided to go public. For one thing, it needed more visibility and credibility in the software industry. But more significant, the company was finding it difficult to compete with Silicon Valley for talent. "Iowa was a hard sell," John Kirk, a co-founder, recalls with a sigh. CE thought stock options would help.

Those were heady times for CE. Revenues shot to $8.6 million in 1991 and profits to a record $1.4 million. Giddy state officials hailed CE for bringing technology to the heartland and grandly proclaimed the company the cornerstone of "Silicon Prairie." For a while, it looked as if the high-tech roller coaster roaring through the economy had made an unexpected stop in Iowa. As sales continued to soar, CE's founders were publicly euphoric but privately worried. The company's fate was tied entirely to Apple Computer and its Macintosh--and not only was Apple hardly a model of corporate stability, but it also was losing ground in the crucial corporate market. In addition, Apple had said it would add e-mail capability to the operating system of the Macintosh, and that could have been disastrous for QuickMail. CE's management knew the key to its survival would be to diversify. "We were living in their orbit," says Gurney. "And Apple will kill you if it is in their interest to do so." (Apple did add e-mail to the Mac's operating system, but it wasn't popular and was eventually dropped.)

CE's weary--and wealthy--founders decided it was time to bring in fresh executive talent. In 1991, they hired Ford Goodman, a highly regarded vice president of sales at Informix, the database software giant in Palo Alto, Calif. Two years later, when he was named chief executive, he took on the job of diversifying CE and decided on a strategy of acquiring promising products. CE thought it had found the answer to its problems in 1994 in a little company called Powercore, which had a calendar and scheduling program for Windows. Analysts were calling such programs the next new thing in the big corporate market. CE agreed to buy Powercore for a total of $3.8 million in cash and 250,000 shares of CE, then valued at about $1 million. It would prove to be a costly disaster.

The deal began to unravel as soon as the ink was dry on the sales contract. CE's engineers discovered the program had flaws in the code. Worse yet, the promised market for calendar and scheduling programs never materialized. After a year of trying to patch up the product, CE dropped the program and sued the former owners, claiming fraud, among other things. The case was settled, but it wasn't much of a victory for CE. The company got back its stock--but not the cash. A series of other acquisitions flopped too. "We were a dismal failure at buying technology," Kirk says ruefully. "We learned you can't buy product. You have to buy the people who make the product."

The Powercore failure seemed to sap CE of a certain zest for innovation--or at least productive innovation. "CE's downfall began with Powercore," says Paul Craven, who worked at the company as a software engineer in 1996 and 1997. Even Gurney seems to agree. "People here became less and less comfortable with taking a risk," he says. Morale plummeted, especially among the programmers and engineers. Some of the best were lured away by better offers at more successful companies. Meanwhile, CE's sales were dropping quarter by quarter. Free Internet e-mail was eroding the market for QuickMail. Apple's problems with the corporate market meant no more growth for QuicKeys. CE's stock sank so low--to 50 cents at one point--that the company was in danger of being thrown off Nasdaq. While other software companies were thrilling shareholders with stock splits, CE had to endure the humiliation of the opposite. (To maintain its listing, CE later did a one-for-five reverse split in 1997.)

Not surprisingly, tensions in the executive suite were high in those difficult years. The founders wanted to fire Goodman. "I want to be tactful," says Kirk, "but we lost a lot of money on his watch." But Goodman wanted out too. Back in Silicon Valley, his colleagues were getting rich in the high-tech gold rush, while he was dealing with death throes in Iowa. So Goodman made a pitch to the board. CE had a promising new software product in the lab. Goodman wanted to take the source code--that is, the digital soul of the new product, which was a program to share and store documents electronically--back to California and start a new firm with the programmers who'd developed it. CE agreed, in 1996, on the condition that Goodman's $75,000 severance pay be used as seed money in the new venture, giving CE a 49% stake.

CE's source code became the kernel of a very successful venture for Goodman. Incredibly, in two years, he sold the new company, which he called Relevance Technologies, for $5 million in cash and $31.5 million in stock to Documentum, a big software company based in Pleasanton, Calif. CE's stake, which had been diluted by successive rounds of financing by venture capitalists, was worth $6.2 million, mostly in Documentum stock. (In selling the stock, CE suffered another spate of bad luck. It sold in batches as the price fell, finally selling its last share at $18. Two months later, the stock doubled, and it's now selling for about $38.)

But back in Iowa, there were no hard feelings. "We got our money's worth," says Kirk. "It was his idea." In selling the stock, CE got a nest egg that would ensure the company's survival for a few more months. But it was facing a management crisis again. Co-founder Richard Skeie wanted to retire from active management, and the company needed to find a new chief. Recruiting would be difficult, and not only because there weren't a lot of seasoned software executives eager to take charge of a company far from the action in Silicon Valley. "Let's face it," says Kirk. "It's hard to find a president for a money-losing company."

CE handed the reins to Gurney, who started at the company in 1991 as a manager of technical support and worked his way up through the ranks. Gurney, who was making $150,000 at the top position, inherited a mess. CE did adapt QuicKeys for Windows in 1998, but it was years too late for the market. In a telling move, CE said it wouldn't spend its nest egg to market the new product. Layoffs and attrition have reduced the work force to 30, about a fifth of what it was in 1990.

Last summer, at the board's suggestion, Gurney and Kirk hit the road to look for someone to rescue CE. All hopes now rest with ATIO. Like CE, however, ATIO is unprofitable, its product line is limited, and customers are few. (For the nine months ended Sept. 30, 1999, ATIO posted a net loss of $2.4 million on revenues of $2 million.) But Kirk thinks the merger will give CE a foothold on the booming Internet.

At least Wall Street seems to think CE has a fighting chance. Shares have been moving up steadily since summer and traded around $9 at press time, a 52-week high. For a while now, investors have been speculating that the company will pair with a hot young startup in the tech business. They were right.

Looking back on 20 years in the software industry, Kirk is philosophical, saying, "We did the best we could at the time. We're going to do something exciting, something hot. We used to have fun at CE, and we'll have fun again. This is a small company, and we'll turn it around. This company can be innovative and profitable, and there's nothing like profits to raise morale."

with reporting by Deborah Branscum

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