Background: Alveolar type 2 (AT2) cells and bronchioalveolar stem cells (BASC) perform critical regenerative functions in response to lung damage. Published data show that nonhematopoietic, bone marrow-derived “very small embryonic-like stem cells” (VSELs) can differentiate in vivo into surfactant protein C (SPC)-producing AT2 cells in the lung. Here, we test directly whether VSEL-derived BASC and AT2 cells function to produce differentiated progeny. Methods: using a reporter mouse in which the H2B-GFP fusion protein is driven from the murine SPC promoter, we tested whether bone marrow-derived VSELs or non-VSEL/nonhematopoietic stem cells (non-VSEL/non-HSCs) can differentiate into AT2 and BASC cells that function as progenitor cells. Immediately following bleomycin administration, WT recipient mice underwent intravenous administration of VSELs or non-VSEL/non-HSCs from SPC H2B-GFP mice. GFP+ AT2 and BASC were isolated and tested for progenitor activity using in vitro organoid assays. Results: after 21 days in vivo, we observed differentiation of VSELs but not non-VSEL/non-HSCs into phenotypic AT2 and BASC consistent with previous data in irradiated recipients. Subsequent in vitro organoid assays revealed that VSEL-derived AT2 and BASC maintained physiological potential for differentiation and self-renewal. Conclusion: these findings prove that VSELs produce functional BASC and AT2 cells, and this may open new avenues using VSELs to develop effective cell therapy approaches for patients with lung injury.