So you want to write an app that has no database! I take it that the client app is a UI for capturing information and storing it on the user's PC. It never reads or writes to a database. Is that right.
You can do this (it took me a second to think this way as we've never had an app with no db before as far as I know).
You started as I would have: "creating business objects based on a sql database model and then dropping the database".
[aside: You don't have to drop the database and I would not. This is your design database and it's good to have it around as you evolve your business object structures. When you ship the app, the db won't exist at the client's site but that will be OK as you're about to see.]
You are correct that DF tries to connect as soon as you call CreateEntity. It will try to connect under almost all circumstances. In this case, it wants to check the database for the current schema info.
You can prevent this by forcing the PM to disconnect BEFORE you use it: PersistenceManager.Disconnect();
Now when you call CreateEntity, the PM knows it can't reach the database and relies on local knowledge of the entity schemas