You can have either a dedicated internal mail server; something hosted in a rack out at an ISP or a completely Cloud-based solution.
The local internal mail server has a great deal going for it, and there are plenty of non-Microsoft options such as Kerio MailServer but if you want to play safe then the product of choice is still Exchange Server 2003 rather than 2007.
The latter brings more flexibility, but much of it is aimed at the larger organisation - and don't overlook 2003's large user knowledge base. If you hit a problem, chances are someone else will have solved it.
A key issue with ES2003 is to ensure you're getting the most from it. For example, many companies limit the user inbox size in an attempt to keep below the 16GB limit of the original ES2003 release.
However, this limit has been raised in recent SP versions, and you should be allowing more online storage of company information if possible. There will be limits to your daily backup schedule that have to be balanced against storage size. But large tape drives have come down in price considerably in recent years.
Another key driver to ensure you're getting the most from your Exchange Server installation is remote usage. For example, many employees will have smartphones capable of picking up email via IMAP.
Careful setup allows them to do so in a secure, encrypted way. The iPhone, for example, can pull email from various accounts. You need to be careful about configuration to ensure your server doesn't end up as a mail relay bot - this isn't difficult.
If you make the move to ES2007, then it's possible to use this to manage the phones too - remote lockdown and wipe both become possible, and this can have an immediate and direct business benefit (see the PC Pro guide to securing a business notebook by visiting www.pcpro.co.uk/links/178secure.
For desktop productivity, don't be afraid of looking away from Microsoft Office if a number of licences are required. The latest version of OpenOffice has matured into a strong platform and, if money is an issue, it costs nothing and can be used to bring another machine into productive use.
If money is available then you can't beat Microsoft Office 2007 for bells and whistles, but only if you back it up with Microsoft's server-side collaboration software. This is a whole different level of investment, and one worth doing if finances allow.