It could be that the System folder wasn't properly "blessed" when it was created. Here's how you "bless" the System folder:

Step 1.) Insert the floppy containing the System folder or Disk Tools floppy on another Mac already running System 7.x.x.

Step 2.) Open up the floppy's disk (Cmd + O) and locate the "System Folder".

Step 3.) Open and then close the "System Folder". (Cmd + O, then Cmd + W)

Step 4.) Eject the floppy. (Cmd + Y, or click and drag the floppy disk icon to the Trash.)

Congratulations! You have now properly "blessed" the System Folder. The disk should now be able to boot up. If that doesn't work, it could be either the floppy drive has problems or the disk may need to be recreated (data corruption on the disk image or of such). Oh, and make sure you are using at minimum version 4.2 of the Disk Copy application when creating the boot floppies. If you're using System 7.x.x on another Mac, you can use Disk Copy version 6.x.x as well. (If you don't have either, PM me and I'll be glad to email you the Disk Copy app of your choice.)

Try it and report back with results!

73s de Phreakout. :rambo: