You need to run the game as admin in win98 compatibility, And you need to run FF7 music as admin in WinXP SP2 compatibility. I had the same issue, But when i did the above FF7 and FF7Music worked like a charm
I tried this, it gave the same error but now I also get an error box saying "No useful indirect path found, check app.log for more information"
App.log says this -
INITIALIZE DD/D3D START
INFO: Auto-detected version: 1.02 US English
INFO: No OpenGL 2.0 support detected, shaders won't be available
INFO: No swap_control extension, cannot control framerate
INFO: Original resolution 640x480, window size 1280x800, output resolution 1280x800, internal resolution 1280x480
INFO: No NPOT texture support
ERROR: init_indirect failed, scaling and postprocessing will be disabled
INFO: internal resolution clamped to 1280x800
LOCK UNLOCK TEST
MATRIX INITIALIZE
INITIALIZE DD/D3D END
initializing sound...