Win7 will make a copy of the data files, not programs (these you will reinstall along with drivers and chip utilities). If the flash takes NTFS use it, if not FAT will work as win7 will read either one.
NTFS has one down side(yet an upside as well, its better in a network or multi user environment) being its permissions. So if you go that route, you may need to take ownership of the files once the reinstall is done.
I use an external drive for backups. The lazy way is to just give the "Everyone" group Read + Execute. You will still want to take owner ship of the drive so you do not have writing issues.
Alternatively, you can just give the "Everyone" group Read + Execute + Modify + Delete(or even go to full control). Just not that if the drive gets lost, anyone can access it with ease(but it is not like they cant just take ownership anyway, if its not encrypted, its not half safe).