Setup includes things like the string set up, neck, bridge, pickups, etc. Electric guitars have a whole bunch of factors that can affect it's tone. With lower quality guitars, you usually get poorer quality factory setups, though that can often be remedied if you bring it to a guitar tech. The guitar tech can resolve problems like fret buzzing and stuff. But there will still be things that he can't change.

As for what guitar to choose, I always suggest you chip in a little more to get a decent guitar. For 500, your choices are rather limited, and most guitars in that range are rather poor. If you choose to continue with that budget, the best advice for you is to check absolutely everything before buying the guitar. And if possible, bring a friend who has more experience than you along.