This is not a business model for startups, because startups don’t need to be weighed down with such crap. This is a business model for the VC firms whose LPs might expect some returns in a decade.

1. Fund a startup that is totally disrupting an existing industry by giving away goods or services for free.
2. Short-sell a corresponding public company whose business model is to provide the same goods or services for, like, money.
3. Profit.

This strategy was first proposed by Joe Weisenthal nearly a decade ago [1], and can be applied to any industry. The disruptive startup operates at a loss until the existing industry is sufficiently disrupted, and then the startup can be used as a tax writeoff. Or sold to Yahoo.

For example, Khosla Ventures just funded a company called Even, which provides interest-free credit. I assume that Keith Rabois then took out a huge short position on Visa and Mastercard.

Are VCs allowed to adopt long/short strategies?

Now take all those startups doing free grocery delivery. The investors ought to say, Look guys, we really need you to give away the groceries for free too. And then short-sell Kroger and Safeway, cuz how can they compete with free? Sure you might dump a few million into the startup itself, but publicly-traded grocery stores have hundreds of billions in market cap to short! That’s the arbitrage opportunity.

References:
1. Arbitraging Free, a Hedge Fund/VC Combo –the Stalwart