Well, hopefully you're young a flexible enough that you can bounce back quickly after learning a valuable lesson.

A few years ago, I worked with a guy for 18 months without pay. I bounced back!

In our case, we didn't try to convince other people to work for us for free.

Now that I think I can read between the lines, give this guy (or gal) about a week to see the error in his ways. Make sure it is on friendly terms. For example, every day, continually engage him (or her) in discussions about the legal issues of employing other people.

If he does not see the error in his ways, torpedo him so that he can't accidentally screw people over like this again.

If he does see the error in his ways, you're going to have to take a personal hit yourself. Disband the company on amicable terms. If it's a good idea, and everybody owns most of the IP, you can get back together in a week or two and find a new leader.