Example:
You have the virtual folder with the content of the folder C:\TEST
C:\TEST contain the shortcut to the folder D:\DATA
When the "Expand shortcuts to folders" is off then TLB show the shortcut and normal menu item. So you can click it to open the folder D:\DATA in the Windows Explorer.
When the "Expand shortcuts to folders" is on TLB show the submenu with the content of D:\DATA instead of the shortcut.
Also note, the option "Expand shortcuts to folders" sets the default behavior. You can right-click the shortcut and select "Expand folder" to control expanding for every shortcut.