Provide free accounts with limits (on the number of things like photos, emails, users, etc. or on storage) with an option to upgrade to a paid monthly subscription account without or relaxed limits and maybe even additional features. Once you upgrade to the paid account, you must either pay to continue or stop using the application.
Works best if you have a product that users get hooked to and will pay to continue using once they have exhausted the limits. Interestingly, the exhausted limits are a good indicator that the user is hooked.
This is different from the Freemium Business Model, in that the differences between the free and paid accounts are in the limits and not necessarily in features alone. It is also different from the Free Trial Period Model that usually has a limit on time, which might result in prompting the user to upgrade to a paid account before they are hooked. I coined this term primarily to differentiate it from these models.
Examples: Wufoo, Flickr, Basecamp
The word freegrade is a portmanteau created by combining the two aspects of the business model: free and upgrade.