Update: According to Game of X, several companies were in Microsoft's eyesights for acquisition, including Nintendo themselves.
Microsoft's Rick Thompson apparently fell in love with Nintendo's business model and attepted to buy the Kyoto company. "So between visits in Redmond and visits in Kyoto, I visited [Nintendo] seven times, and in my ugly American way, I just came right out and said,'I want to buy you guys.'"
Nintendo declined, but reportedly a partnership was being investigated of a joint product running Nintendo software and Microsoft hardware. However, that too never advanced as Nintendo didn't want to look like they "lost" to Microsoft by approving of a new hardware from the eventual competitor.
The announcement of the Xbox was a fascinating moment in gaming history. Computer giant Microsoft jumped into the video game fray, fulfilling the role of player three in today's console gaming trinity. But only recently was it revealed that in anticipation of the jump to console gaming, Microsoft was seeking acquisitions for the new Xbox venture, including Square. The deal was reportedly called off at the very last minute.
As first spotted on ResetEra by member "Dancrane212" the story of Microsoft and SquareSoft was reported in Rusel DeMaria's recent Xbox history book, Game of X.
In 1999, Microsoft met with SquareSoft while courting various companies for acquisition. Microsoft apparently wanted to get its hands on the Final Fantasy IP. Xbox's director of business development Bob McBreen revealed that discussions with SquareSoft reached all the way to the final stages where the two companies were about to sign the deal.
According to the book, "It was November 1999. There was a deal on the table and Steve Ballmer, who was in Japan on a sales tour, attended a celebratory dinner the night befor the final meeting."
However, it was at the final meeting that the CEO of Square, who at the time would've been Hisashi Suzuki, stood up and said there was an error. Suzuki reportedly said that, "before we sign, our banker would like to say something," which at point the banker declared, "we want more money." Apparently right there on the spot Square doubled their price.
According to Square, the valuation of the company had some errors, declaring that it was actually worth more money than the deal proposed. Head of Xbox hardware Rick Thompson revealed that "[Square] wanted something like one and a half billion dollars for half of the company," which caused Microsoft to balk. The dea was called off.
The Xbox launched in North America in 2001, without Square. Meanwhile Square merged with Enix in 2003 to become Square Enix.
While we don't know what that deal between Square and Microsoft ultimately would have looked like, it should be noted that the Final Fantasy series did eventually come to the Xbox console with Final Fantasy XI on the Xbox 360. So in that way, things might have worked out for the best in the end anyways.
Updated the story with some additional quotes directly from Game of X.