(fix minor phrasing error.)
Even if that were not the case, I say report them. You'll be helping the other people in the company that you like by preventing the CEO from walking over them in the future (if the CEO would do it to another officer of the company, they would certainly do it to the rank and file). It will also set an example to other start-up founders not to screw over people they want to employ.
My guess is that the founder is three steps out of the poor house himself (or herself.)
1. Decide you are going to leave, be confident it's the right choice (it is)
2. Protect yourself, by understanding the legal implications with your own research or with a lawyer.
3. As the person in the position of power here (you are) have compassion.
4. Explain that you cannot stay, but you don't want to hurt them unnecessarily.
5.Make a plan for equity compensation, full rights to all of your work (at least for your own and further commercial use), while allowing them to use it under a license that doesn't blow up their lives.
6. Write your letter of recommendation for moving on to the next thing, and have it be clear that you finding job security is a necessary condition for things to proceed.
...Or, blow it all up, while trying to minimize the negative consequences for yourself. Which could be fair enough.
This is not my personal experience.
> As the person in the position of power here (you are) have compassion.
He just got robbed of months of wages. Sure, he has the hand, but he's still undeniably the victim.
I'm all for compassion, and understanding but sometimes things are quite clear cut. I'm not arguing for vendetta, just reparation.
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.