This is a question there in mind for long time. There are hundreds of free services in web which doesn't have any ads or anything. It's totally free. Angels are raising fund these company and ultimately how the get their money back?
There are several business which has both free and paid version of software. They could make money by selling the paid version and get the popularity for the product spread by free versions. This one of the successful business model. One of the examples are evernote which is a huge success with freemium model.
But still there are some sites services out there. The best examples are
Tumblr & Posterous - Popular micro blogging sites. In a normal user perspective they've no option for them to make money unless their business get acquired by some big shots. Yet another examples are Mozilla, opera etc. How they could make money for their operation and return profit to the investors?
Of course Google services are free but their revenue from other departments are redirected to various businesses.
This isn't so much about short-term money as about generating long-term value.
Some startups will gain funding because they are disruptive, can gain a solid market position, have some competitive advantage and for other reasons not directly associated with short-term revenue generation.
These things are often a long-game, whereby investors know that with low-costs and a potentially significant position that can translate to future long-term profits, the investment is the swapping of cash for the asset of the company position and future potential. Mozilla Foundation for example, generate revenue through Googles searches from that handy little search box next to the address bar:
A footnote in Mozilla's 2006 financialA significant figure, non-profit or not! If someone came to me with an elevator pitch, "Fund my business, and my browser will have 25% market share" ... I'm pretty sure I would hear them out.
report states "Mozilla has a contract
with a search engine provider for
royalties. The contract originally
expired in November 2006, however
Google renewed the contract until
November 2008 and has now renewed the
contract through 2011.
Approximately 85% of Mozilla’s revenue
for 2006 was derived from this
contract." This amounts to
approximately US$56.8 millionapproximately US$56.8 million
Tumblr on the other are thinking (or are) charging for themes, addons and extras for people's blogs [ http://latimesblogs.latimes.com/technology/2010/04/tumblr-ads.html ], but investors invested before knowing for sure the plans. TechCrunch reports that Posterous is inserting Amazon and similar affiliate links in people's posts when they post a URL in the page.
The internet moves so fast, that being first to market can often be a significant factor. Look at things like Twitter, whose business model is still being eeked out. Investors know what they are doing ... users and data are an asset with value providing that you can make an exit/generate revenue long term and pay costs in the mean time either through some non-detrimental revenue generation, bootstrapping/cash diversion or investment.
It will boil down to profit in the end. It is more like tooling a factory I suppose.
I recon it is good that startups are looking at new revenue models, and I am glad the VCs and Angels take the risks to enable them to do that. I'm sick of ads.
I found the book Free by Chris Anderson a good way to think about these issues. He showed how a product that looks free can actually earn money in some other way.
Specifically, on free products with investors - investors do not expect all of their businesses to succeed, they just don't know which ones will. So, they invest a (comparatively) small amount in a number of companies and hope enough of them will find the way to make money from 'free'.
Mozilla is a non-profit organization, they never intend to make a profit.
Overall though, even the startup founders themselves have no idea how to start generating profit. It's mostly a three step plan:
1) Get a lot of users
Check out the book Free by Chris Anderson as Alexandre noted. It's a fanastic book on the subject and it's extremely interesting. It squarely addresses the quesiton you posed. Also, there is a free digital copy floating out there that the author released.