Explanation
Box 1: Remove the public IP address from VM1
If the Public IP on VM1 is set to Dynamic, that means it is a Public IP with Basic SKU because Public IPs with Standard SKU have Static assignments by default, that cannot be changed. We cannot associate Basic SKUs IPs with Standard SKUs LBs. One cannot create a backend SLB pool if the VM to be associated has a Public IP. For Private IP it doesn't matter weather it is dynamic or static, still we can add the such VM into the SLB backend pool.
Box 2: Create and configure an NSG
Standard Load Balancer is built on the zero trust network security model at its core. Standard Load Balancer secure by default and is part of your virtual network. The virtual network is a private and isolated network.
This means Standard Load Balancers and Standard Public IP addresses are closed to inbound flows unless opened by Network Security Groups. NSGs are used to explicitly permit allowed traffic. If you do not have an NSG on a subnet or NIC of your virtual machine resource, traffic is not allowed to reach this resource. To learn more about NSGs and how to apply them for your scenario, see Network Security Groups. Basic Load Balancer is open to the internet by default.
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Reference:
https://docs.microsoft.com/en-us/azure/load-balancer/quickstart-load-balancer-standard-public-portal
https://docs.microsoft.com/en-us/azure/load-balancer/load-balancer-overview