Create VHD file from a folder

First pitfall/issue - there's no support for VHD files in most third party products. For example, if you get a virus and you need to boot from an antivirus CD, the antivirus software won't scan inside the VHD. You'll scan, clean up the hard drive, and then when you reboot into Windows you'll still have the virus.

Next - backup images are going to be more complicated. If you use something like Acronis TrueImage for backups, you have to make sure to back up the contents of the VHD, not the VHD itself. The VHD's timestamp will change every time you use it, and so to backup software, it'll look like a huge file that has to be recopied to the backup every single time the backup runs. In reality, only a few files have changed inside the VHD, and you only need to back those up.

Next - you said "when reinstalling you just need a copy of the VHD" - imagine that your next OS isn't compatible with the disk partition style you chose. You have to copy the VHD off to another drive (like a USB drive) and then copy it back. Why hassle with that when you could just partition and keep it separate and stable? If you have to copy it off the drive anyway, you can use any partition imaging software like TrueImage or its open source clones to copy the partition to an external disk.

I'm not sure about repairing the actual disk or the details of the VHD container format but if you haven't tried mounting outside of the Virtual Server environment proper, that may be worth a try.

Apparently, WinImage can mount VHD containers: http://www.winimage.com/winimage.htm