Upgrade merges 3 (or more) to raise the level of the highest (locationally, not lvl) hero in the list. It does not consider the lvl of any of the sacrificed heros, which means you can sacrifice a lvl 6 to make a lvl 2 for example. Upgrade didn't even appear for me until the 8th round (8 wins, 0 losses), when after having like 15 benched penguins, which all got sacrificed instead of just the minimum required 3.
Selling is 100% return value, but considers all heros to be lvl 1. (selling upgraded heros is a big loss)