Get a lawyer involved. You stated that the ex-founder is a bit litigious. So, anything that you send or that a representative of your company sends is likely to not be taken seriously. A letter from a lawyer will probably work better. The lawyer can also help you during the negotiations process. Of course, in the event that the ex-founder files a lawsuit, the lawyer can represent you.
Was the ex-founder (and existing founders) considered employees? If so, then you are bound to follow California law related to minimum wage. As others have mentioned, though, you may be able to buy back the shares or negotiate them (although if he is fully vested, I doubt he will agree to that).
I know you stated that you really don’t have the money to pay the minimum wage and so I wonder about your financial standing for the shares. You really need to take some time and evaluate the financial standing of your company and how it can get back on track.
If you cannot get the ex-founder to settle for something reasonable (if that’s what an attorney who is representing you says you should aim to do), you might want to simply dissolve what you have and start over. Make sure everything for the business is in writing. Make sure that the business is financially solvent. Make sure you have in writing whether founders are considered employees. Talk about what happens with vested shares. Maybe consider putting in a founder clause about how these sorts of disputes (anything that could be a legal dispute) should be handled (such as mediation or arbitration).
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