Create a blank CHD CHDMAN -createblankhd <chdfile> <cylinders> <heads> <sectors>
The cylinder/heads/sectors parameter are not very relevant, SCSI does not care about these, but 100 16 50 will produce a ~40MB CHD.
Follow Anna's instructions above, (but using MESS instead of Unz, of course), and it should work fine.
Currently trying to get MESS to do a TownsOS installation - it generally works, but a disk error occurs at a certain point, although you can continue with the installation, the HD crashes on boot. Probably just a minor glitch, but finding it might be difficult...