This is only two cents' worth, but there are a few things you must first discover: What do you personally want out of life, our of your career, out of this company, out of this deal? What does the VC want, in as much detail as you can understand? It may be critical to understand why your VC behaved that way and what his reasoning was for doing so. Also, it sounds like you are describing a liquidation preference, which is common down-side protection that only has a big impact when you miss the goals. It is part of the insurance they demand to take the risk. In both cases, this includes ideas like "to make money", "to feel like I was treated fair", "to feel like I made the best decision available", etc. Then, what is the best alternative to your current situation? What is the VC's best alternative to the current situation? Finally, is it at all possible to find a way, any way, for you both to get as much as you want? It is important to try to keep the negotiation from being about who has more power (worst) or who is right (bad). It should be about what you both want.

You've got a good team. You have successfully served a niche. Now what? Spin off the existing product and start from scratch? Take the technology and launch a new product, while managing the cash flow of the existing customer base? Much of this depends on what you want: a good lifestyle (where you should bootstrap) or to get rich (where you should take on a VC).

Since the relationship with the investor is important, try hard to repair it or find a new investor somehow, even by starting over.

I know the advice is very generic, but I hope that helped.