A few years ago NCTomatoman, from Tomatoville.com, m, fibally posted a series of videos about his dense planting technique. I've used it for bith tomatoes and peppers without problems.
Here's a link.
http://www.youtube.com/watch?v=nLbeZEcz3sw&feature=youtube_gdata_player
So long as you don't pop the main root, the seedlings can typically handle the abuse.
If the media is loose enough, one should be able to separate roots quite easily unless the plants are getting too old.
I also vote for separating when the first or second set if true leaves have appeared.