ESXi 3.5 to vSphere ESX upgrade - best practices?

No need to format your old esx 3.5 server ,you can upgrade your esx3.5 to esx4.0 by host upgrade utility but your hardware must be 64bit because esx4.0 requires 64bit hardware.it will not harm your existing virtual machines resided on your esx 3.5.
you need to format old virtual center 2.5 and then install new virtual center 3.5.you can take a backup of your virtual center 2.5 database if u requires.

You will not be able to upgrade from ESXi to vSphere 4.0. Also you mentioned that new hardware will be available only after some weeks. So you have to upgrade/install on the existing hardware. Take backup of VMs. Note down Network details of which VM is connected to which vSwitch and which vSwitch is connected to which NIC, etc.
1) Fresh Install ESX4 on ESXi 3.5
2) install vCenter 4  (If you want then may be on a separate Windows Machine than on same Virtual Center 2.5)
3) Connect to iSCSI Storage
3) Import VMs and ensure networking is as per the original ESXi
4)When the new hardware comes, install vSphere 4 and connect it to vCenter 4.0
5) Ensure network labels are same as the first vSphere 4.0
5) Configure Cluster and enable HA and DRS.

Amit, read again, he is using esxi not esx and if you are interested you can read the official upgrade guide as well
http://www.vmware.com/pdf/vsphere4/r40/vsp_40_upgrade_guide.pdf

I don't see why everybody is telling the poster to backup the VMs. Hopefully he does that as a matter of course, but since his VM's are all on the SAN (ICSI), upgrading/splatting the existing ESX install will not affect his VMs (as long as the ESX installer doesn't format the SAN volume - tip: ensure you disconnect storage while setting up an ESX server - we do that as a safety measure)

So I would recommend this: Wait for your new hardware to arrive. Install vSphere ESX on this, configure as appropriate, and then present the Same LUN to your new server. Then you can power off the VM's on the current ESXi server, and register and start them on the new ESX server.

Of course what could make it easier, is to install vCenter now, add the current server to vCenter, wait for the new ESX server to arrive, install /configure/etc, then vMotion the VM's from the old ESXi server to the new ESX server. Then you can upgrade the ESXi Server to ESX (if you have two ESX licences of course). Also by then using vSphere vCenter as the point of entry into your VI infrastructure (a combination of ESXi 3 and vSphere 4), you can not worry about needing to use the VI2.5 client.

my humble 2p.

thanks for your help, but im still running into a few problems.

I've followed za_mkh's advice, as it ran parallel to my initial thoughts. I've installed vCenter 4.0 onto a 2003 R2 VM on our current ESXi 3.5 server, but cannot add the ESXi 3.5 host to it. It is complaining that adding an older host requires a License Server, and without one it wont work. I went into the Licensing portion of vCenter 4 and attmpted to add 27000@servername as a licensing server. It took this fine, and then let me get 1 step further in adding the ESXi 3.5 host. It shows me all the VMs, and at the final import of it will eventually timeout with "There are no License servers available" or some similar shit.

I then used Infrastructure Client 2.5 to connect to my ESXi host and attempted to change the licesning from a key to a license server, and added 27000@vcenterservername . This just times out and says "No licensing server found."

Am I missing something super obvious? Is there actually a licensing server portion im supposed to install?

Or do i even need to have the ESXi host on my vCenter 4.0? The plan is to migrate all the VM's to the new server w/ vsphere 4.0 when it arrives. Will i be able to do that w/o having ESXi in the vCenter? IE: just connect vCenter to the SAN datastore, and right-click/add to inventory one the new host?

Hopefully this makes sense :)

justin