A Sectoid can use this ability on another Sectoid (and in multiplayer, any unit) in Line of Sight. The ability grants +25 Critical Chance, +25 Will, and 1 additional Health to the receiving unit for one turn. The transmitting unit gets no bonus. If the transmitting unit is killed, the receiving unit also perishes.
A Sectoid can Mind Merge with a Mechtoid (in multiplayer, any unit in LoS) to grant it a Psi Shield instead of the usual bonuses. The ability grants 5 Health to the receiving unit for one turn. Should the transmitting Sectoid be killed, the feedback causes the shield to implode and the Mechtoid suffers 3 damage instead of dying.
Mind Merge often does more harm than good; it means one less Sectoid shooting at the player, it gives the possibility of a double kill by killing the Mind Merge transmitter, and worst of all, it is a dead giveaway of the positioning of 2 Sectoids in the fog of war for easy aiming of long ranged explosive attacks such as Fire Rocket.
Don't get too eager about double kills - overextending your units could open up weak positioning that the enemy can exploit next turn. This is especially true when playing in multiplayer, as enemies may Mind Merge two expendable units to bait you into a trap.