Surely, quite apart from the state aid legality, a fundamental problem is a clear non-alignment of the respective government & shareholder aims?
The government apparently wants regional connectivity, yet the owners have no particular altruism re such a focus and presumably will be quite happy to dump such minor regional routes routes for LHR slots or feed, or to apply potential government funds (rather than raising their own risk capital) to international (suicidal) start ups, such as those allegedly being considered from LHR & LCY.
If the government wishes to assist the public and the regional airports, it should find a direct mechanism to do so, perhaps by simply tendering PSOs on the critical domestic routes (which would flush out any healthier alternative contenders).
The suggestion of a loan (presumably unsecured by VS/DL?) in lieu of owner's money is simply a "heads we win, tails they lose" for VS/DL, which leaves the latter with either a successfully revived Flybe or a deferred collapse, both at no cost to themselves.