They start life as an egg state, similar to an upside-down blue turnip with a yellow peak. When they hatch, they can be trained to be different attributes and emotional states. The chao from Sonic Adventure 2 can also favour "dark" and "light" sides which can lead to variations in visual evolution. Depending on the game, they take various times to evolve. When evolving they go back into their cocoon state (similar to their normal egg state) for a small amount of time. This is true to every game except NiGHTS Into Dreams. In Sonic Adventure 2, it will take about 8-9 hours spent in a Chao Garden before they either die or reincarnate (depending on how you treat them). They can reincarnate infinite times if treated well before dying (although this may vary in different games). Chaos can also be trained to "ultimate forms" such as the Chaos Chao, the Devil Chao and the Angel Chao. This is only true to the Adventure series. The three variations are all immortal, but do not have the ability to mate and make more chao.
Chao can be trained with Chaos Drives from robot enemies (From the government controlled enemies) in "action" stages or animals (This also changes to fruits and other objects in later games, and they cannot be trained in NiGHTS Into Dreams. Getting the drives from enemies also changes in favour of trading them for RINGs in future games). Animals can also affect their appearance, for instance to gain Rabbit ears. Again this is changed in different games to have little or no effect. Further information on this can be found on the internet.
Chao originally came from NiGHTS Into Dreams on the Sega Saturn where they looked like small elves (peach coloured) with bald heads and little blue clothes, a very different visual effect. However, despite their lower IQ to modern chao, the chao from NiGHTS Into Dreams did have emotions which were reflected in the music they sang and the music in the stages. These chao could die and become cross-bred with stage enemies, and were born from small white eggs similar to a birds.
Possibly the most famous Chao is Cheese the Chao, the (invincible) partner of Cream the Rabbit (the walking, talking and flying rabbit) which can be seen in action in Sonic games (Namely Sonic Advance 2 and the up-and-coming Sonic Heroes) as well as being a character in Sonic X, a sonic anime that is now airing in America.
As with the Chao of earlier Sonic manga and magazines, Cheese retorts "Chao Chao Chao" instead of talking. This is said to be taking advantage of the pokemon craze, but this is not true as many fictional Japanese animals said their name rather then talking long before pokemon. However, this speech aspect is not true to all Chao, as Chao from the games often purr meow or make simple noises rather then simply saying their name.
Chao is also part of Discordianism
You may have been looking for Manu Chao