I assumed that the characters that successfully completed a dungeon would retain their level and equipment. That was not so I'm confused how you upgrade your existing heroes? When they enter a new dungeon they start at lvl 1 and lose all their equipment.

You can't really "upgrade" your heroes outside the dungeons. You can unlock better loot to drop in dungeons, new starter items and better hero classes only upon expanding your guild.

Heroes enter dungeons vanilla, that is, without any equipment except for their assigned starter item, if any. In order to get some basic equipment for your hero and to level up, you must defeat weaker monsters each time you enter a new dungeon.

exactly, i just found that out, we have to find stuff, and we can choose one thing i guess from whats found, so far i am doing okay

it takes a while to get used to the playsystem , on my crt 17 inch i see it at 1024x768
i wanted it to run in 800x600 in a window so i could also watch the resource hogging better, but at 1024 its quite alright :D
look at my hero's muscles and my cards

check screenshot of my hero
i won now i can choose loot: check choose_your_loot image

mouse over the loot and wait info pops up and you can see what it gives you, if you have it ,it shows other info

check screenshot : mouse_over_loot

click on hero and see info, too bad its obscured by an object on my 1024x768 crt monitor
check: click_on_hero_and_see_info

so this game will give you some hours of fun :D
so far i can beat any low level enemy with my eyes closed

this one is stronger, check screenshot: this_one_is_stro.jpg

i hope this gave you some examples of what kind of things to expect, i assume its totally random so you will be finding other items i guess.