It may not be quite the only alternative.
1. You could presumably run it from an external SCSI hard drive.
2. You might, with a little ingenuity, manage to configure and run it temporarily from a ram disk, assuming you have at least 8MB, say, installed in the machine. It is not to be recommended without an actual HD, but it might just work. The trouble would then be that, should the machine lose power, you'd have to start again from scratch. Hardly worth the effort.
3. It might be possible to rehabilitate a HD. Possible problems include: stiction, incorrect formatting or missing driver. There is also the question of the accompanying hardware in the PowerBook. Is the cable sound, for instance? Is power getting to the drive? (E.g., I have a 280c that seems to have a fuse blown, because a hard drive just won't turn in it.) Unless you know what you are doing (many here do not; and I mostly do not when it comes to fuses and such), it would be worth describing exactly what you have done with the drives, and what happens when you try to boot from each, including, e.g., what you hear when you turn on the machine. Happily, such testing is very easy to accomplish with a 540c, given the location of the drive.
4. Equill is arguably the resident expert on drive rehabilitation methods here; send him a PM if he does not appear. He also has a clear interest in the 540c.
You do really need a hard drive in any machine that requires System 7 to run, although you might JUST manage to run something like Nisus Compact or Write Now from a floppy that also contains an absolutely minimal system install. It will, however, be wasted on the king of the 68k powerbooks, the 540c, as operation from a floppy will be dead slow.
A replacement 2.5" scsi would not be that hard to find. They still populate most of the 68k powerbooks for sale/ trade in the usual places, and this, I suspect, would be your best bet. Alternatively, post a WTB a 2.5" scsi HD here in the appropriate forum; though one suspects that most of us want to hold onto as many as possible of those precious little objects that we have as spares, there are others who are wanting to get rid of things and you never know your luck.