There are a number of different types of these "Free" walking tours, with the business models varying dramatically. In some countries you can expect to end up at the guides "cousins" carpet shop, where the guide will take a kick-back for any sales. Some tours are run by the local community and/or volunteers and truly are free (although with the potential for small tips which will often go to the organization rather than the guide).
And then there's organizations like Sandemans.
Sandeman's hit the press a few years ago when German TV station ZDF did an expose on how they operate. Google will give you all of the allegations and counter-claims (search for sandeman zdf), but in short Sandeman's were claimed to be charging their "freelance" tour guides ~3 Euro for every person who was on the tour. The tour guides would then push the guests for "tips", often including repeated comparisons to similar "commercial" tours, and the prices that the guests would be paying if they had taken one of those tours rather than their "free" tour.
If a guest tips 10 Euro, the guide would have made 7 Euro out of them. If another guest tips nothing, then the guide would be out of pocket 3 Euro. Either way the company has made 3 Euro per guest.
Whether this is a valid business model, and whether you should support such companies/guides is something that is probably best left up to each of us individually.